Despite the ongoing recession and carnage ongoing in the labor market, the 2Q09 earnings season in many respects has been nothing short of spectacular. According to the Wall Street Journal, 337 companies in the S&P 500 have already reported. Of these companies, 74% beat earnings expectations, 9% reported inline results and 17% actually missed earnings. The typical average is for 61% of companies to beat expectations, 19% to report inline results and 20% to miss. Not only have more companies exceeded consensus expectations, but they are beating estimates by a wider margin. According to Standard and Poors, companies have exceeded estimates by approximately 14% on average thus far for 2Q09, which represents the widest margin since 1994. Companies deftly managed costs even when many missed topline expectations. Stop us if you’ve heard this one before: Company XYZ missed revenue targets but beat earnings expectations. Either way, the bar was set too low heading into earnings season.
As a result, stocks had a fantastic month in July. The S&P 500 increased 7.4% for the month and the market has had its best five month performance in the past 70 years. Of course the question now is have we come too far too fast? We think it is helpful to look at comments from executives over the past few weeks across a broad cross-section of industries to gain a better sense of where we stand from an economic perspective and how executives see demand evolving over the next few quarters. As part of this analysis, we are also going to take a look at how the market responded to these comments in terms of stock price performance (did the stocks trade up or down, how do they look technically, did they “break out” or “break down” etc.). The market’s reaction to management statements will tell us a lot about expectations for the economy over the next 6-9 months.
For this exercise, we have gathered quotes from eleven management teams on their most recent earnings conference calls. Some of the companies will be familiar to almost everyone, others are not as widely followed but serve critical end-markets for the economy. Before we get started, we would like to thank the folks at SeekingAlpha, who provide an invaluable service to the investment community by providing conference call transcripts for free to the general public. Here are the questions about which we hope to gain more insight:
- As we have stated in the past, we are firm believers in Edward Leamer’s thesis that housing is the business cycle. We also asserted back in early May that the volume of new and existing home sales had already bottomed. What are key operators serving the housing market saying about current demand trends and the state of a housing recovery?
- Unlike the residential real estate market there has been very little price discovery in commercial real estate. Many investors view commercial real estate as the next shoe to drop in the economy. At this stage, has transaction or leasing activity shown any signs of stabilization? If not, when can we expect signs of stabilization?
- In our report on the office furniture industry, we argued that based exclusively on the change in non-farm payrolls, this is the worst labor market in the past 70 years. We view temporary staffing as one of the best leading indicators of future economic trends. After two years of hemorrhaging jobs at an unprecedented rate, what do trends in the temporary staffing industry tell us about the potential for stabilization in the broader labor market?
- There has been a fairly rigorous debate ongoing in the investment community about the state of inventories in the channel. According to the preliminary second quarter GDP report, business inventories declined a record $141 billion after a $114 billion reduction in the first quarter. Are we done with inventory destocking and will inventory restocking significantly boost growth in the second half?
- Copper has long been lauded as a coincident, if not leading indicator of economic growth. In our view, it is the single most important metal to track. Copper prices are up substantially thus far this year. However, it is not clear whether or not this is a function of inventory stockpiling by China or the result of expectations for stronger demand from the rest of the world. What has the impact of Chinese stockpiling been on the price of copper and where does demand otherwise stand?
- The administration’s economic stimulus package was passed with great fanfare, but it still is not clear what impact, if any it has had on the economy. How has the economic stimulus package impacted economic growth thus far and will it provide a boost to the US economy going forward?
- It appears liquidity in the capital markets has improved, but not without significant help from the Fed. We are focused on liquidity for smaller companies, those which are often the source of great innovation and paradigm changes that can often spark secular bull markets (think electricity in the 1920’s, automobile proliferation in the 1950’s, globalization and the internet from 1982-2000). Venture capital is a key source of funding for smaller companies. However, historically funding has dried up during periods of economic weakness even though that is often the period during which game-changing companies are spawned. What do current trends in the IPO market tell us about the state of venture capital?
Question 1:What are key operators serving the housing market saying about current demand trends and the state of a housing recovery?
Company: Standard Pacific Corp. (SPF)
Importance: One of the largest homebuilders in the country, with a strong presence in California the first housing bubble market to crash
“The Company’s cancellation rate for the three months ended June 30, 2009 was 16%, down from 24% for the 2009 first quarter and 25% for the 2008 second quarter. The Company’s sales absorption rate for the 2009 second quarter was 2.7 per month per community, up from the prior year second quarter rate of 2.0 per month per community, and up from 1.5 per month per community for the 2009 first quarter. The improvement in the Company’s sales absorption rate during the quarter as compared to the 2008 second quarter was due to increases in most of its markets on a per community basis with absorption rates particularly stronger in California and Arizona“
Conclusion: SPF’s results are clear signs of progress in former bubble markets. As we discussed in one of our earlier posts, sales trends in former bubble markets such as Arizona, California and Las Vegas have improved substantially. REO and foreclosure sales have been the primary drivers of volume growth in these markets. The inventory of new homes in these markets is remarkably lean, but the continued flow of foreclosure properties will keep a cap on a large improvement in the market for new homes.
Market reaction: The stock jumped 11.9% on the day following the earnings release. Technically speaking the stock broke out of an 8-month trading range.
Company: Builders FirstSource, Inc.
Importance: BLDR is a leading supplier and manufacturer of structural and related building products to the residential new construction market
“The company cannot predict the duration of the current market conditions or the strength of future recovery in the housing market. However, we expect the difficult conditions to continue into 2010.“
Conclusion: BLDR’s revenue prospects are exclusively tied to new home construction, which we do not expect to improve materially until 2010 at the earliest. Any recovery in our view will be gradual. However it is important to note that the overall inventory of new homes is now at 40-year lows and any uptick in demand would reduce the months supply rapidly.
Market reaction: The stock jumped14% the day after the company’s earnings release, in large part due to the company’s improved liquidity position. The stock also broke out of an 8-month trading range and appears to be close to testing its 52-week high.
One final word of note on housing. One of the bigger issues that we’ve had about this current rally from a technical perspective is the lack of a breakout for the homebuilders. Looking at the 1-year chart of the XHB below, you can see that the ETF is bumping up against it’s trading range for the past 9-months or so. We remain skeptical about a strong recovery in new home sales in the next 12-months and it appears the street does as well.
Question 2: At this stage, has transaction or leasing activity (in commercial real estate) shown any signs of stabilization? If not, when can we expect signs of stabilization?
Company: CB Richard Ellis Group
Importance: The world’s largest commercial real estate brokerage firm
“I wouldn’t characterize June as a strong month and I wouldn’t characterize the market place has haven’t seen any particularly strong activity in the back portion of the second quarter. I do know and this maybe answer what you were referring to, I do know that in New York, which is a valuable market. There was a sense that transaction activity, leasing activity picked up a bit in the second quarter. But, I would say that globally or perhaps more importantly to our investors, the larger markets around the world, the leasing business remains very much depressed and more abound and the sales market is just in a very-very similar condition as it was in the first quarter.”
Conclusion: Exposure to commercial real estate remains an overhang on the balance sheets of most money-center and regional banks. Similar to what transpired in 2007 and most of 2008, we expect a long period of limited activity until commercial properties enter the foreclosure process. We think price discovery in the commercial real estate market will go a long way towards enhancing investor confidence that “the coast is clear”. Unfortunately the magnitude of job losses, the lack of available funding for commercial real estate and limited investor appetite suggest that the we might not see the “commercial real estate shoe” drop until 2010 at the earliest.
Market reaction: CBG’s stock rallied 5.2% following the earnings release. This has as much to do with investor enthusiasm about the company’s improved balance sheet than anything else.
Question 3: After two years of hemorrhaging jobs at an unprecedented rate, what do trends in the temporary staffing industry tell us about the potential for stabilization in the broader labor market?
Company: Spherion Corp.
Importance: Spherion is one of the largest temporary staffing firms in the country.
“As we stated last quarter, during March, we began to see signs of stability in our weekly revenue trends, and I’m pleased to be able to report that this stability generally continued throughout the second quarter. I’m also encouraged by our discussions with several of our clients who are beginning to prepare for future hiring needs in a recovering economy. Although jobs numbers are not yet improving, at least we’re seeing some deceleration in the decline. For the second quarter, total Spherion revenues declined 3.9% sequentially, evidence that we cannot yet predict that we’ve reached the bottom of this employment recession. However, revenues per day were only about 1% less in June than in March. On the staffing services side, revenues per day were higher in June than in March. From past recessions we know that commercial staffing; especially industrial staffing is the first to begin growing. Therefore, our 4.4% sequential growth in industrial staffing this quarter is very encouraging.”
Conclusion: Fundamentally speaking, we see little reason to bid up temporary staffing stocks, although the companies are doing a reasonably good job of managing their businesses for profitability in this downturn. True Blue,Inc., another temporary staffing firm that focuses in “blue collar” jobs witnessed solid sequential improvement in revenues. As doubtful as we are about a meaningful recovery in job growth over the next 12-18 months, we cannot underestimate the importance of what temporary staffing firms are witnessing. These are strong indicators of a potential upswing in job growth in the coming months and should be watched carefully.
Market Reaction: Who would have guessed that staffing firms are breaking out? For now we’re going to treat this as a “false dawn” but if trends continue to improve the historical playbook on staffers remains in place. Bid them up early in the cycle when the lionshare of gains occur. Still at this stage we view these names as potential short candidates.
Question 4: Are we done with inventory destocking and will inventory restocking significantly boost growth in the second half?
Company: Texas Instruments Inc.
Importance: One of the largest manufacturers of semiconductors in the world
“Now I’ll characterize sequential growth as we believe it relates to inventory and in-demand, as customers and distributors slowed the rate at which they are reducing inventory, our shipments continue to rise toward the level of in-demand. Although it is difficult to identify specific inventory levels and trends at OEM and EMS customers, we don’t believe inventory is generally building; instead, it likely continued to decline in the second quarter, although at a less rate than in the first quarter. We have better clarity on inventory at our distributors. Working with our distributors, we reduced inventory in the channel by about 10% in the quarter. As you would expect, this rate of inventory reduction was less than last quarter, as our sales into the channel begin to approach the rate at which our distributors are selling TI product out of the channel.”
Conclusion: TXNis painting a picture of equilibrium in the channel at this point. We can see a scenario in which the manufacturer’s that TXN serves start to build a bit more inventory heading into holiday season (which would impact Q3 for TXN). At this stage it would appear that destocking is mostly complete, but TXN management has yet to paint a picture of a desparate lack of product in the channel, particularly when one excludes Asian demand. A tepid outlook from both Microsoft and Qualcom added further cloudiness to the state of true demand for tech.
Market Reaction: TXN’s stock sold off a few percent following its earnings release. The stock has not done much in the two weeks following earnings. Overall, technically speaking TXN remains in a solid uptrend.
Company: Caterpillar Inc.
Importance: One of the world’s largest manufacturer’s of construction and mining equipment
“Dealer inventory changes had a very sizeable impact in the change on quarter-over-quarter sales. Dealers lowered machine inventories almost $1.2 billion during the second quarter. That means that our sales of new machines were about $1.2 billion below dealer sales to end users. To put the year-over-year impact on sales in perspective you also need to understand what happened last year. During the second quarter of last year, dealers increased inventory about $200 million. That means that dealer inventory changes had a negative impact on our quarter-to-quarter sales of about $1.4 billion. One final point about sales and its impact on dealer inventory, there is no doubt the significant reduction in dealer inventory had a substantial negative impact on our sales. As painful as that was, the good news is that we are well down the path to getting it behind us. That is not to say that it is over. In fact, we expect more in the second half. So far this year, dealers have taken out almost $1.5 billion and that could grow to nearly $3 billion before 2009 is over with the lion’s share of what is remaining this year likely to be in the third quarter. As a result of continuing weak demand and expected declines in dealer inventory, we have significant rolling factor shut downs planned for the third quarter. The third quarter is likely to be very tough in terms of sales and as a result on profit.”
Conclusion:The impact of inventory destocking still remains a significant headwind for CAT, but the company has tried to establish that the destocking process could be completed by the end of this year. It appears that inventories in the industrial channel still have not fully adjusted to the current demand environment unlike tech.
Market reaction: Who needs revenue growth when you can cut costs? The market responded favorably to CAT’s results and increased guidance, the stock traded up 7% on the day of earnings. We think CAT’s results helped solidify the S&P 500’s move above 950. The technical picture implies a slight breakout for CAT or a pending double top formation.
Question 5: What has the impact of Chinese stockpiling been on the price of copper and where does demand otherwise stand?
Company: Freeport-Mcmoran Copper & Gold
Importance: One of the world’s largest miner’s of copper and gold
“From a market standpoint, the recent upward movement in copper prices reflects some important fundamentals about this business that are going to be important for the long run. And that is the requirements for copper in China and the developing world. I mean that’s an important feature of our industry that’s become apparent in the 2000s and it’s going to be something that’s long-term. To build infrastructure, to expand economies requires copper. We are certainly seeing that in China, as China has been doing that. And it’s in the context of a very tight market. Exchange stocks have dropped dramatically, but inventories around the world today outside of accumulations of China apparently for their strategic reserves of copper, but inventories of consumers around the world are very, very tight and even in the United States where market conditions remain weak.
We have orders from customers when they do have requirements for copper that they aren’t able to fill from their inventories and so in the context of a weak environment in the U.S. and the western world, inventories are very low. The industry has and continues to face issues with new projects, maintaining supplies out of existing mines. So the supply situation for copper is very well situated for miners”
Conclusion: It’s clear that China has been a huge source of incremental demand for copper this decade and in particular this past year. The longer term case for copper is very difficult to refute. However there are growing signs that China’s stimulus and massive infusion of liquidity could be coming to an end. We expect copper to sustain $2.00+ going forward, but that doesn’t mean that a pull back isn’t in store, even if inventories are tight by historical standards in the U.S. and Europe.
Market Impact: FCX’s stock had a lackluster response to blowout earnings. Since that time the stock has once again tested $60, which appears to be resistance for the stock. On a side note, FCX is one of our favorite stocks to own. The company is exposed to geopolitical risk, but has superior assets and should be purchased on any material decline in shares.
Question 6: How has the economic stimulus package impacted economic growth thus far and will it provide a boost to the US economy going forward?
Company: Union Pacific
Importance: One of the largest railroad operators in the US, the circulation engine of the US economy
“We’re starting to see some stimulus project activity, but so far it’s still hard for us to tell whether it’s generating the incremental projects or just shifting the source of funding….I think the stimulus money, I think most people were pretty up, maybe overly optimistic on its affect on the timing. What we see with some of our local groups we work with, most of them aren’t going to see real dollars spent until the later part of the year.”
Conclusion: Those are fairly damning comments about the stimulus package. UNP ships autos, lumber, coal, and a host of other materials whose demand would be directly impacted by effective stimulus.
Company: Martin Marietta Materials, Inc.
Importance: Martin Marietta Materials is a leading producer of construction aggregates and would be a direct beneficiary of any large scale public works or infrastructure projects
“As we have consistently indicated, we have expected our 2009 performance to be driven primarily by anticipated economic growth in the second half of the year. This growth was to be principally fueled by federal economic stimulus, or the American Recovery and Reinvestment Act, which was specifically crafted to provide for increased construction and for investment in the nation’s infrastructure.
Among other things, this stimulus program was designed to address job creation as well as the underlying demand in infrastructure repair and expansion together with industrial-related construction activity. While we have seen an increase in bidding activity for infrastructure projects and awarding of projects to successful bidders by a significant number of states, we now believe that 25% of projects will commence later in the year with most of the remainder coming in 2010. The pace at which these projects have moved to the actual construction stage, to date, is slower than expected even though the majority of the work is resurfacing. Aside from the federal programs, a number of states are challenged with their own budgets as revenues decline. This has caused most states to pull back and defer on state funded projects.“
Conclusion: Thus far the American Recovery and Reinvestment Act (aka the stimulus package) has been a non-factor in terms of contributing to overall economic growth. Growth in 2010 will be supplemented by work related to the stimulus package, but in terms of preventing further job losses this year or actually stabilizing the economy the package has thus far proven to be ineffective. At this stage, it appears most investors have discounted any contribution from the stimulus package so any activity going forward as a result of stimulus funding could be viewed as upside.
Market reaction: MLM shares traded off 3.4% on the day after they lowered guidance in part as a result of a lack of project work from the stimulus package. The stock has rallied over the past two-weeks inline with the market. However, overall, MLM shares remain range bound.
Question 7: What do current trends in the IPO market tell us about the state of venture capital?
Company: Thomas Weisel Partners Group
Importance: Founded by the former head of Montgomery Securities, Thomas Weisel Partners Group is one of the leading boutique investment banks in the country with a strong focus in traditional growth areas such as technology, media and healthcare
“I think from an investing standpoint, the venture capital community as a whole has really slowed down their pace of investments. They’re doing a lot of triage. Many industries have been severely adversely affected and they’re coddling the better and concentrating on their better investments and I think the issue there is that there are many companies in the portfolios that could do an IPO now. The question is do they want to do it within the pricing structure that exists and that’s a question that many companies are asking themselves and their boards and I think you’re going to see a pretty substantial pickup in the first half of next year in venture backed IPOs.
So I think you’ll start seeing a big pickup and we’re obviously engaged in dozens and dozens of these kind of conversations.”
Conclusion: Through the end of the second quarter there were 14 IPOs in the US that raised a total of $2.7 billion. This compares to 43 IPOs in the US in the first six months of 2008 that raised a total of $27.7 billion. The number of IPOs did increase sequentially from the first quarter to the second quarter, but overall the level of activity is woeful. Venture capital firms use the IPO market as one of their primary exit strategies. Until investor appetite for IPOs improves, we do not see a scenario in which venture funding to smaller, innovative companies will improve. It is interesting that investors have been more than willing to bid up riskier assets in the public markets in this recent rally in stocks, yet access to capital for smaller private companies remains virtually closed.
Market reaction: TWPG shares traded off 11.5% following the company’s earnings release and conference call. From a technical perspective, it appears there was a breakdown from an upward trend. The company’s revenue and earnings prospects are highly contingent upon capital markets and M&A activity for small emerging growth companies. It appears the market is not convinced we’ve seen a revival in growth capital.
As always, please act accordingly…
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