Supply Chain and Higher Cost Issues are a Constant Theme Despite Positive Earnings
Some Familiar Faces Making Big Moves in the IPO Markets
Companies with Cash Issues Can be a Big Drag on a Country and a Portfolio
(Friday Market Open) The S&P 500 (SPX) created a new all-time high on Thursday but just barely. Despite a seven-day up streak, the move may not be as convincing to some investors, so follow-through on Friday could be important. Fortunately, the S&P 500 futures are pointing slightly higher before the market open. However, the Nasdaq Composite (COMP:GIDS) is trending lower with negative news on Snap (SNAP) and Intel (INTC).
The owner of social media platform Snapchat, Snap, traded 20% lower in after-hours trading on Thursday after reporting better than expected earnings and revenue, but provided a lower-than-expected outlook. The company is projecting much lower sales in the future. One reason for the sales issue is a change in the privacy restriction for Apple (AAPL) products.
Semiconductor manufacturer Intel beat earnings estimates despite falling short on revenue. Of course, demand for computer chips is still very high, but according to The Wall Street Journal, there’s a 22-week lag between ordering chips and delivering them. Intel does plan to invest $95 billion into increasing chip-production capacity in its European plants to help make up for the semiconductor shortage.
Chipotle Mexican Grill (CMG) was able to beat top and bottom line numbers despite rising food and labor costs. Americans appear to be tiring of their own pandemic cooking and getting more food on the go. The company saw a 15.1% increase in sales, which was much higher than the 13.4% analysts were expecting.
Appliance maker Whirlpool (WHR) missed on revenue but beat earnings, which took the stock 2.84% lower in after-hours trading. Third-quarter sales were up about 4% on strong consumer demand. Net earnings margins grew despite the rising cost of raw materials. However, the company cut its fiscal year sales growth guidance from 16% to 13% year-over-year but raised its earnings guidance.
Similar themes of higher costs and supply chain issues continued into Friday morning as companies like Honeywell (HON), Roper (ROP), Schlumberger (SLB) and VF (VFC) beat on earnings but missed on revenues as management wrestles with inflation and supply chain issues. However, Financial stocks continue to do well with American Express (AXP) beating on both top and bottom line numbers.
Financials have benefited from rising yields and the current action in the bond markets suggest that they could continue to benefit. In recent days, the 2-year and 10-year Treasury yields are creating new 52-week highs. Bond investors appear to be pricing in a rate hike in 2022 because the Fed may need to address rising inflation sooner rather than later.
In the middle of the earnings news, a few IPOs with some familiar faces made a big splash on Thursday.
Former President Donald Trump took his social media SPAC, Digital World Acquisition (DWACU) public. The company is launching a rival social media platform called Truth Social. The IPO climbed more than 400% on the opening day and was halted several times with over 500 million shares traded. The company raised $283 million. Trump Media & Technology Group plans to merge with the new IPO.
Additionally, Chicago favorite Portillo’s (PTLO) went public climbing more than 45%. The company plans to grow from 67 restaurants to more than 600 in the next 25 years. In honor of the occasion, I had a Chicago beef sausage combo with sweet peppers.
Before investing in any new stock offering, be sure that you are fully aware of the risks involved with this type of investing. There are a variety of risk factors typically associated with investing in new issue securities, any one of which may have a material and adverse effect on the price of the issuer’s common stock.
After the Chinese real estate developer Evergrande’s financial problems took center stage earlier this month, many investors were concerned that it would be a Lehman Brothers-like contagion that could lead to a new credit crisis. The contagion is spreading, but it doesn’t appear to be as severe as the 2007 credit crisis.
On Tuesday, the Financial Times reported that Chinese building contractor Sinic Holdings defaulted on $246 million worth of bonds that matured on Monday. Earlier this month, The Wall Street Journal reported that Chinese luxury apartment developer Fantasia Holdings had defaulted on $206 million worth of bonds.
Sinic and Fantasia are more companies added to the growing list of Chinese real estate developers ending up in the junk bond markets. Other developers include Kaisa Group, Central China Real Estate, and Sunac China Holdings. Along with Sinic’s news, credit rating agencies downgraded even more developers.
While the credit contagion appears to be spreading throughout China, investors don’t seem to be worried about it hurting the U.S. economy. In fact, Reuters reported that fund company BlackRock (BLK) and investment banks HSBC (HSBC) and UBS (UBS) are among the be biggest buyers of the junk debt. However, not all fund companies are as bullish on these bonds. Fidelity, Pimco, and Allianz all reported that they were reducing their positions.
CHART OF THE DAY: CHINESE DEVELOPMENTS. The Morningstar China Index ($MSCNUSDP—candlesticks) was outpacing the S&P 500 Index (SPX—pink) much of the last two years but has since slid backwards. Data source: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.
Price Control: The difference between what companies are paying for their materials and the price that consumers pay for final products can often vary. Companies realize it can be difficult to pass on price increases like Unilever (UL) did when it hiked prices 4% last quarter. Unilever was able to do so without hurting its sales and therefore maintained its profit margins.
However, when you compare last week’s Producer Price Index (PPI) to the Consumer Price Index (CPI) like Liz Ann Sonders does in her latest market commentary, you have to wonder how long can these companies can absorb the higher costs without killing their margins.
Companies with high-demand products often have “price control”. While many investors wondered how Apple could charge more than $1,000 for a phone, the company was able to do it because it has a dedicated and loyal customer base. Perhaps Unilever was successful because it deals in smaller items like cleaning, hygiene, and food products, and consumers just aren’t pinching pennies yet. Eventually, the costs are likely to catch up to these companies and margins will likely suffer.
Wide Moat: Many investors try to find stocks that have a “wide moat” around its core business or products. A wide moat is an advantage a company has over its competition. This advantage helps maintain its profitability.
Companies that have a wide moat commonly have a lot of cash on hand, bring in more revenue and profits than competitors, have high name recognition, and a superior product that commands loyalty. Wide moat companies have the potential to maintain their profit margins as the costs of materials rise.
Cash Returns on Invested Capital: A common tool that investors use when trying to identify companies with a wide moat is the Cash Returns on Invested Capital (CROIC) ratio. One way you can calculate CROIC is by dividing EBITDA by the Total Equity Value. Generally speaking, the higher the ratio, the better.
I’m not going to bore you with the math, but I do want to point out that this ratio really emphasizes the production of cash. In fact, it reflects a common investing idiom that “cash is king”. The ratio helps identify how effective management is at producing cash from its business. A wide moat filled with cash can help a company absorb rising costs.
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