Jozi, Jozi 26o 12' 16" S, 28o 2' 44" E. We had US earnings to contend with and as I always say, this is my favourite season, earnings season. On Friday we had a McDonald's miss, a rare one, which we will discuss in detail later. GE was a meet on the bottom, but a miss on the top. We will also look at GE results a little later. Richemont has had a couple of poor days after what can only be described as the most amazing run I have seen for quite some time, mostly as a result of lower Swiss watch exports to Asia. But as a WSJ article pointed out, companies have been pointing out that sales to Asians are better, tourists have been buying the cheaper product in Europe. Reason being is that the taxes on luxury goods in Europe, which are manufactured locally (in Europe) have a cheaper price tag. And are therefore more attractive. We have heard stories from clients and I have seen with my own eyes the luxury branded stores that are full of Asian tourists, mostly Chinese folks. The Communist party crack down on heavy spending will undoubtedly throw the luxury brands a curveball. Or should I use the term reverse swing, that is more appropriate considering that the Wanderers is a whole 2km from where I sit.
All fall down for the indices across the board, the all share sank nearly three quarters of a percent to comfortably below that 37 thousand mark it had been clinging to. Banks lost a percent, gold miners fell the most amongst the resource majors, the bullion price was under some pressure. Platinum stocks actually went in the other direction. There was the story that Cynthia Carroll, the Anglo American CEO had met with both the ministers of Finance and the Mines and she had come away with a positive feeling about the country, but said that the government needs to have a firmer hand: Anglo boss urges tough line to halt mine unrest. I saw an analyst note about Anglo's iron ore project in Brazil, one of their four major growth projects reveal nothing flattering for the company. Yech! Over budget and nowhere near the original timeline, almost two years behind. The only fellow who scored big here was none other than Eike Batista. If you don't know what I am talking about, cast your mind back: MMX Minas-Rio and MMX Amapa. Phew, big price tag back then and lots of money spent so far in developing the asset.
Did you see the government response to the Economist article from last week? If not, then follow the link: South Africa is getting many things right. This is true, life for ordinary South Africans are much better than they were from 20 years ago. But what immediately struck me was that the response missed a key point made in the Economist about corruption amongst the ruling elite. Check out the original article from the Economist: Cry, the beloved country. I thought that the loss of the moral compass and corruption was a bigger issue which explained why the Economist thought we were on a slippery slope. So, I went to the government response and checked for the word corruption. Not once. Check it out:
Again, is it fair to point out the short comings when not pointing out all the good work that has been done? I think yes, we want excellence, not ordinary. And corruption is a massive problem, because once it is entrenched as common place in a society, it becomes incredibly hard to undo. Just ask the Greeks, yes, ask them! Paying to jump queues at the hospital. Amongst other things. But the commitment is there, I suspect that this is why you have seen the fall in sales in Italy, because of all the new legislation. So whilst we can agree that government has done lots to improve the lives of many, it is the current worry about corruption that weighs on us. The medium-term budgetary speech should be more than just interesting on Thursday. The sober truth.
Digest these links..
Poor buggers in Greece, you might think that their problems are "rich people problems" but often the most vulnerable in society suffer. The suicide rate is up, people are genuinely suffering. This article paints a gloomy short term picture: On Greece: More Austerity, More Recession, More Extremism. I agree with that last piece. If there was just 18 months of sideways economic activity, that would bring about the stability that Greece so desperately needs. Much of these painful austerity measures are as a result of spending too much when times were wonderful, and the reason that they were wonderful was as a result of too much spending. By individuals, municipalities and governments. Greece's economy might have contracted roughly 15 percent from the 2008 high's but it is still three times bigger than it was 20 years ago. In percentage terms, the Greeks economic growth rate has crushed the Germans over two decades. I bet you didn't expect to hear that. All I am saying is that whilst they are going through an incredibly tough patch now, things are seemingly better than twenty years ago. Perhaps I am just thinking out loud with blinkers having seen the data Greece Gross Domestic Product.
Staying with austerity and humans adapting, I was pretty amazed with this story from Rome in the WSJ titled: Electric Bikes Go on a Roll in Rome. Humans adapt to the changing environment around them by looking for cheaper solutions. And that point again about Italy, 1000 Euros sales in Italy can no longer be cash sales. Much cheaper and better for folks to be on the roads using bicycles, that amazing figure of electric bicycle sales to top 50 thousand this year compared to NONE five years ago. Humans adapt, and the cost savings benefits (as well as health benefits) are huge.
Perhaps the French government should take a careful look at this little factoid, via the Carpe Diem blog Tax fact of the day. It is worth a copy paste: "In 1921, when the tax rate on people making over $100,000 a year was 73 percent, the federal government collected a little over $700 million in income taxes, of which 30 percent was paid by those making over $100,000. By 1929, after a series of tax rate reductions had cut the tax rate to 24 percent on those making over $100,000, the federal government collected more than a billion dollars in income taxes, of which 65 percent was collected from those making over $100,000. - Thomas Sowell" Now some context is needed, those were massive boom years for the US. But obviously a cut in tax rates led to higher collections for government, because people spent more, not less. And as we well know, private money sweats a lot harder than public money, no matter where you are in the world.
Remember just last week we were talking about the completely new Microsoft operating system, check this out: Windows 8 Is Really Confusing. That one line makes me a little worried for shareholders: "It feels like it's a tablet operating system that Microsoft managed to twist and shoehorn onto a desktop." We wait Friday, in what is already a very busy week earnings wise to see what the reception is to the latest and perhaps biggest change ever in Windows history.
What is happening? Well, that is a question I ask my mum or dad every time I call them, what's happening in that sprawling metropolis? I think, and I stand corrected here that the little Klein Karoo town that they live in does not have a single traffic light. You could run around the small town in half an hour, which means that it is pretty small! But I am not talking about that "town", I am rather talking about the biggest stock market in the world and the most important consumers in the world. If you take a squiz at this article from the WSJ (subscription only, sorry): Falling Revenue Dings Stocks you might be forgiven for feeling a little glum. And then the associated headline from the same publication: Unhappy Anniversary, Dow. Sis.
But wait a second here, because if you look under the hood a little closer at the state of the consumer, you start to see signs that you would enjoy as an equity investor, again, same publication: The Once-Mighty U.S. Consumer Awakens. We have been pointing out for a few months now that the health of the housing market in the US is at the best levels for more than half a decade. This is starting to reveal that there is rising consumer confidence and more importantly, housing prices are starting to rise. In this last article, there is a very important point made, the share of after-tax income that is spent on food, financial obligations and energy has fallen to levels last seen in 1998. Pent up demand has seen motor vehicle sales surge to a four year high. Obviously people do not buy new cars unless they are more certain about the future.
See that one key paragraph in that story:
- "Meanwhile, Americans' spending power is high. In the second quarter, according to Federal Reserve and Commerce Department figures, they devoted a combined 28.2% of their after-tax income to food, energy and financial obligations like mortgage payments and rent. That matched the fourth quarter of 1998 for the lowest share on record going back to 1980."
I wait with bated breath to see whether I am right or wrong, but I suspect that whilst people might be looking at companies and saying that "things" are awful and we are seeing no top line growth, I suspect that they might be looking in the wrong direction.
There is a lot of evidence to corroborate the recent uptick in housing and the consumer improving, and these links were all via Mark J. Perry in his weekend links, firstly: California Foreclosure Activity Lowest Since Early 2007. Yes. And, a strange measure indeed but: St. Louis Fed Financial Stress Index (STLFSI) is at pre recessionary levels. Indicating exactly what the release is, lower financial stress on all parties since before there was an economic downturn. Which explains why the consumer is less anxious and is buying more houses and more cars than at any time in the last five years. And I am guessing that if you have a look at credit extension in the US, you no doubt will see that rising. Of course it is not all sweet fresh cream, but I suspect that when sales start rising, businesses are in an extraordinary space to start dominating with all the serious cost cutting having been done already.
- Byron's beats
On Friday we received third quarter numbers from one of our biggest holdings in New York, the massive conglomerate General Electric. This company who has businesses all over the world breaks up their interests into two main categories, Infrastructure and Finance. Infrastructure includes GE's involvement in manufacturing equipment for energy, health, transportation and technology. The finance division works like a bank with a more focused structure helping GE as a whole capitalise on market specific opportunities, according to their website.
Of their $36.3bn revenue for the quarter, $24.7bn came from industrial sales while $11.4bn came from capital revenue from the financial division. This was up 3% from last year thanks to 7% growth from industrial sales despite a 5% decrease in their financial division. That is because they are trying to decrease their reliance on this division going forward. It is a strategy we are happy with as you will know our long term positivity on the big banks is very muted mainly due to risks and regulations.
The infrastructure division is of course further broken down. Here is the revenue breakdown. Energy $12.1bn, aviation $4.8bn, healthcare $4.3bn, transport $1.4bn, Home & Business Solutions $2.2bn. All this revenue amounted to $3.8bn of operating earnings which was up 10% from last year thanks to efficient cost cutting. Per share this equated to 33c which was below expectations of 36c. The stock is expected to make $1.55 for the full year. Currently at $22 they are trading on forward 2012 earnings of 14.3. For a company looking to grow earnings around 12% next year I would say that is fair.
We feel the company is exposed to the right sectors. As the global economy grows the demand for energy, healthcare and transport will certainly increase. They have a massive alternative energy division so if you are looking for a green investment GE fits the requirements. They have been focusing heavily on developing markets which is now responsible for $8.9bn of their industrial revenue. Like I mentioned earlier, we are happy with their strategy to become less reliant on GE capital. This also has a negative impact on current growth with the future in mind.
Earnings were a miss which caused the stock to fall over 3%. It is however up 27% so far this year so the market had high expectations. Sales targets were trimmed which is a theme we have seen this earnings season as top line growth slows down. There is only so much cost cutting a company can do but we are positive this will turn for GE and the whole US economy as the housing market starts pushing confidence. We will carry on adding to this stock, especially when it pulls back like Friday.
Mr. Market was certainly not lovin' it, when it came to the McDonald's numbers on Friday. That jingle might be simple, but it certainly sticks. The currency had quite a big impact, and earnings were dampened by as much as a 8 cents per share. But a miss is a miss, the stock sold off aggressively Friday, down 4.46 percent to 88.72 Dollars. The stock is down over five percent in the last month.
Why is this company important to get a handle on global growth though? Well, as per the Morningstar description, it is easy to see why: "McDonald's generates revenue through company-owned restaurants, franchise royalties, and licensing pacts. Restaurants offer a uniform value-priced menu, with some regional variations. As of March 2012, there were 33,500 locations in 119 countries, including 27,100 franchisees/affiliates units and 6,400 company units." So, they employ a lot of people across most of the world and most people with franchise agreements would be feeling how good and or otherwise the global consumer is feeling. As the chief, Don Thompson said on the conference call: "McDonald's is a destination for more than 69 million customers every day because we are for great tasting high quality goods and an increasingly more modern and contemporary restaurants.". 69 million folks a day eat at the company.
Sales were flat when compared to the corresponding quarter this time last year, but when measured in constant currencies (a Mac is sold in Euros in Paris, Berlin and Rome of course) sales rose 4 percent. Operating income sank four percent, earnings per share sank a percent to 1.43 Dollars a share for the third quarter. So far for the year (three quarters) currency headwinds have amounted to 16 US cents, half of that in the last quarter. BUT, and this is a big but too, whilst recently the currency would have been positive for them, the Euro has weakened against the Dollar, McDonald's chief revealed on the conference call that currently October same store sales were "trending negative." That does not exactly sound appealing, now does it? If the expectations are for a flat, or marginally better year, why would you want to pay more than the 16 times current earnings?
What do I like about the company? Well, there is one thing that will always underpin the price, especially in the current environment and that is the dividend. In September the quarterly dividend was upped a whopping ten percent to 77 US cents per quarter which translates to 3.08 USD a year or a yield just shy of 3.5 percent at the current share price. So, as per the note I read, this should provide a floor. But that means nothing to those people who want to buy this company looking for a superior return, better than they can get elsewhere in the market. This company is never going to explode with growth in sales of twenty percent. Nope. But, at current levels it is definitely a buy. An unbroken 36 years of increasing their dividend makes the company attractive as an investment proposition. Their grand plan is to have a store in each neighbourhood. I would say that they are a long way away from that!
Crows nest. It is a huge week. No really. 140 S&P 500 companies report this week. Which mean that this time next week we would be half way through earnings season. Apple this week, Facebook, Amazon, Caterpillar, it is going to be awesome.
Sasha Naryshkine and Byron Lotter
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