Monthly Archives: May 2017

continuing apparel retailing woes

May 24, 2017 By in Current Market Thoughts, Retail, Uncategorized Tags: , , Leave a comment

I haven’t been watching publicly traded apparel retailers carefully for years.  For me, the issues/problems in picking winners in this area have been legion.  There’s the generational shift in spending power from Baby Boomers to Millennials, the move from bricks-and-mortar to online, the lingering effects of recession on spending power and spending habits.  And then, of course, there’s the normal movement of retailers in and out of fashion.

I’m not saying that retail isn’t worth following.  I just find it too hard to find solid ground to build an investment thesis on.  Maybe the pace of change is too rapid for me.  Maybe I don’t have a good enough feel for how Millennials regard apparel–or whether retiring Boomers are using their accumulated inventories of fashion clothing rather than adding to them.

Having said that, I’m still surprised–shocked, actually–at how the current quarter for apparel retailers is playing out.  It seems like every day a new retailer is reporting quarterly earnings that fall below management guidance, usually the latest in a string of sub-par quarters.  That itself isn’t so unusual.

But the stocks react by plummeting.

You’d think that the market would have caught on that Retailland is facing structural headwinds.  Or at least, that the retail area that made the careers of so many active managers over the past twenty or thirty years doesn’t exist any more.

 

Is it robot traders?  Is it an effect of continuing buying by index funds?  I don’t know.  But the continuing inability of investors to factor into stock prices the continuing slump of apparel retailers is certainly odd.

Warren Buffett and Amazon (AMZN)

May 23, 2017 By in Strategy, Uncategorized Tags: , , 1 Comment

I read a recent comment Warren Buffett made expressing his regret at never having bought AMZN.

As far as I can see–and I’ve never met Mr. Buffett–he’s an urbane, sophisticated, complex individual who chooses a down-home persona to market himself to the world.  I don’t regard anything he says that involves the stock market as being a stray, off-the-cuff remark.  I wonder what he meant.

the top ten

As of March 31st, Berkshire Hathaway’s top ten holdings are, in order:

Kraft Heinz

Wells Fargo

Apple

Coca Cola

American Express

IBM (adjusted down for Buffett’s announced intention to pare his holding by 30%)

Phillips 66

US Bancorp

Charter Communications

Moody’s.

Source:  CNBC (a format that allows easy sorting of the SEC data)

The list comprises 80% of Berkshire’s equities.

 

Yes, despite Buffett’s well-advertised aversion to tech, there are two IT names in the top ten.  But IBM is cutting edge tech circa 1975 and AAPL is a high-end smartphone company looking for a new world to conquer.

the Buffett approach

All these firms do have the signature Buffett look:  they have all spent tons of money developing important consumer-facing brand names.  While that spending has created an enduring consumer franchise, there is no hint of the existence of this key asset on the balance sheet.  Rather, the all-important brand-building expenditure is accounted for as a subtraction from asset value.

The one possible exception to this is Charter, whose cable networks rather than sterling service and extensive advertising give it near-monopoly access to customers.  Here again, however, the ability to gradually write off the cost of constructing those networks through depreciation argues that the balance sheet severely understates their true worth.

The formula, in brief:  the “hidden” value of extensive well-staffed distribution networks plus iconic brands built through extensive spending on advertising and promotion.

limitations

The obvious limitations of this approach are:  that while novel in the 1950s, the whole world has since adopted Buffett’s once-pioneering approach; this would be great if there were no internet undermining the value of traditional brand names and distribution networks.

In other words, a software-driven, internet-based firm like AMZN seems to me to be the last thing that would ever be on the Buffett radar.  It also seems to me that taking AMZN seriously would mean rethinking the the whole Buffett investment approach–not the valuation discipline, but the idea of the value of traditional intangibles–and recasting it in a much techier way.

why not adapt?

Why not do so anyway, instead of kind of limping to the finish line?

Maybe it’s because that doing so would attack the heart of the intangible brand value of Berkshire Hathaway itself–and that attack would come not just from a nobody but from the brand’s most credible spokesperson, the Sage of Omaha himself.

 

what about last Wednesday?

May 22, 2017 By in Current Market Thoughts, managing in a flat market, Strategy, Uncategorized Tags: , Leave a comment

That’s the day the S&P 500 took a dramatic 2% plunge, with recent market leaders doing considerably worse than that, right after the index had reached a high of 2400.

Despite closing a hair’s breadth above the lows–normally a bad sign–the market reversed course on Thursday and has been steadily climbing since.  The prior leadership–globally-oriented secular growth areas like technology–has also reasserted itself.

My thoughts:

–generally speaking, the market is proceeding on a post-Trump rally/anti-Trump agenda course.  Emphasis is on companies with global reach rather than domestic focus, and secular change beneficiaries rather than winners from potential government action that have little other appeal

–while trying to figure out whether the market is expensive or cheap in absolute terms is extremely difficult–and acting on such thoughts is to be avoided whenever possible–the valuation of the S&P in general looks stretched to me.  Tech especially so.  This is especially true if corporate tax reform ends up being a non-starter.  My best guess is that the market flattens out rather than goes down.  But as I wrote a second or two ago absolute direction predictions are fraught with peril

–tech is up by 17.0% this year through last Friday, in a market that’s up 6.4%.  Over the past 12 months, tech is up by 35.2% vs. a gain of 16.8% for the S&P.  Rotation into second-line names appears to me to be under way, suggesting I’m not alone in my valuation concerns

–currency movements are important to note:  the € is up by about 10% this year against the $, other major currencies by about half that amount.  Why this is happening is less important, I think, than that it is–because it implies $-oriented investors will continue to favor global names

–the next move?  I think it will eventually be back into Trump-motivated issues.  For right now, though, it’s probably more important to identify and eliminate faltering tech names among our holdings (on the argument that if they can’t perform in the current environment, when will they?).  My biggest worry is that “eventually” may be a long time in coming.

 

 

the Sears “going concern” warning

May 19, 2017 By in Accounting, Retail, Uncategorized Tags: , , , , , Leave a comment

the auditor’s opinion

On my first day of OJT in equity securities analysis, the instructor asked our class what the most important page of a company’s annual report/10k filing is.  The correct answer, which escaped most of us, is:  the one that contains the auditor’s assessment of the accuracy of the financials and the state of health of the company.  The auditor’s report is usually brief and formulaic.  Longer = trouble.

Anything less than a clean bill of health is a matter grave concern.  The worst situation is one in which the auditor expresses doubt about the firm’s ability to remain a going concern.

a new financial accounting rule

In today’s world, that class would be a little different.  Yes, the auditor’s opinion is the single most important thing.  But new, post-recession financial accounting rules that go into effect with the 2016 reporting year require the company itself to point out any risks it sees to its ability to remain in business.

the Sears case

That’s what Sears did when it issued its 2016 financials in late March.  What’s odd about this trailblazing instance is that while the firm raised the question, its auditors issued an “unqualified” (meaning clean-bill-of-health) opinion.

what’s going on?

Suppliers to retail study their customers’ operations very carefully, with a particular eye on creditworthiness.  That’s because trade creditors fall at the absolute back of the line for repayment in the case of a customer bankruptcy.  They don’t get unsold merchandise back; the money from their sale will likely go to interests higher up on the repayment food chain–like employee salaries/pensions and secured creditors.  So their receivable claims are pretty much toast.

Because of this, at the slightest whiff of trouble, and to limit the damage a bankruptcy might cause them, suppliers begin to shrink the amount and assortment of merchandise, and the terms of payment for them, that they offer to a troubled customer.   My reading of the Sears CEO’s recent blog post is that this process has already started there.

It may also be, assuming I’m correct, that the effects are not yet visible in the working capital data from 2016 that an auditor might look at.  Hence the unqualified statement.  But we’re at the very earliest stage with the new accounting rules, so nothing is 100% clear.

breaking a contract?

Sears has complained in the same blog post about the behavior of one supplier, Hong Kong-based One World, which supplies Craftsman-branded power tools to Sears through its Techtronic subsidiary.  Techtronic apparently wants to unilaterally tear up its contract  with Sears and stop sending any merchandise.

Obviously, Sears can’t allow this to happen.  It’s not only the importance of the Craftsman line.  If One World is successful, other suppliers who may have been more sympathetic to Sears will doubtless expect similar treatment.

Developments here are well worth monitoring, not only for Sears, but as a template for how new rules will affect other retailers.

 

 

 

political risk/Nixon impeachment

May 18, 2017 By in Uncategorized Leave a comment

Last week a reader asked me to comment on these two issues.  Here goes:

political risk

When investors talk about political instability/risk, they typically think about stuff that happens in emerging economies, like a country:

–defaulting on its international borrowings (think: Cuba or Argentina)

–changing tax or other laws retroactively (think: India)

–arbitrarily seizing foreign-owned assets (lots of places)

–having judicial ruling that favor locals no matter what the facts/law say (again, lots of places)

–having rigged elections (lots…)

–having crony capitalism (think: Russia)

–overthrowing the sitting government by military coup (lots…)

In sum, no matter what we think about partisan politics in the US, the EU or Japan, these are by far the most politically stable places for investors on earth.  The US, in my view, is the most stable–although arguably this is in part because I think I understand the rules of the game.

Having said that, I think there is an important stock market issue now beginning to play out in Washington.

As I see it, Donald Trump, an outsider, was elected in part on his promises to “Drain the Swamp,” to reform corporate taxation and to dramatically increase government spending on infrastructure.  At the very least, this is why the S&P 500 has risen by 15% since the election.  So far, however, he has demonstrated poor judgment, a lack of focus and an inability to grasp the basics of how to do the job he now has.   Of course, Washington insiders of all stripes haven’t been particularly helpful.

From a stock market point of view, though, if what we’ve seen so far from Mr. Trump is all he has to offer, it will be very hard for world stock markets to move higher–and we could lose, say, half of the post-election gains as investors come to terms with this failing.  

As I’ve been pointing out for some months, the “Trump trade” ran out of steam around inauguration time.  This may mean, ironically, that Trump stocks will be relative outperformers in any feet-of-clay correction.
Nixon impeachment

I’m taking this question as really being “What can we learn about the stock market during Nixon’s impeachment that we might apply if Trump suffers the same fate.”

Two modern presidents have been impeached, Nixon and Clinton.  So the sample is very small.

In the Nixon case, his impeachment wasn’t the only stock price depressing game in town.  During the same time frame we had:

–the first oil shock, with prices tripling

–the UK economy collapsing, requiring the IMF to prop it up

–the gold-based fixed-rate international currency exchange system in place since the end of WWII falling apart

–the early Seventies speculative stock market bubble, roughly the equivalent of the Internet bubble of 1998-2000, popping.

So while there may have been stock market weakness around the impeachment, it would be hard to factor out the other stuff.

As to Clinton, who was actually tried by the Senate, in January 1999, and acquitted, the market scarcely noticed.  Of course, Internet mania was just getting a head of steam then.  And unlike Nixon, Clinton remained very popular at the time–particularly among women.  Go figure.

As to assessing Mr. Trump’s stock market impact, I think a lot depends on whether his possible demise would be read as the fate of a hero done in by an entrenched, self-interested political elite defending its privileges or of a real estate bungler brought to fame as a reality host and elected in a win-the-lottery series of fortunate accidents.  In other words, would a Trump demise mean the end of the government reform movement–increasing the likelihood of a Japan-like economic fate for the US.