Transcript Notes: July 2022
We’ve gotten so much positive feedback from our monthly Reading Roundups that we’re going to experiment with another new format — Transcript Notes. We started this blog to “show our work” (influenced by Austin Kleon’s book) and this series will allow us to show you some of the company-specific tidbits we find interesting. As always, comment below or reply to this email and let us know what you think. If you enjoy our work feel free to share it. — Matt & Dan
One of the downside of capital-intensive businesses is that some of the profits need to be re-invested to support growth, making them unavailable to shareholders.
At Investor Day, we said that we expected SCB to be higher and made it clear that in the near term, share buybacks would be significantly reduced in order to build capital for the increased requirements. In light of the SCB coming in even higher than expected, we have paused buybacks for the near term.
Cintas has an incredible growth track record.
We increased the dividend 26.7%. We have increased the dividend every year since going public, which is 38 consecutive years…
Cintas has grown revenue and adjusted EPS in 51 of the past 53 years and our prospects for continued profitable growth are great.
They result in part from a strong value proposition and a vast total addressable market. Every business, goods producing or services providing, has a need for image, safety, cleanliness or compliance. Operating a business is increasingly complex. Rather than doing it themselves, business is increasingly outsourced to Cintas. We provide the products and perform the services better, faster and economically frame businesses to concentrate on their core competency.
Demand is high.
There is more demand for rail service than what we are able to satisfy.
The semi-conductor shortage is easing.
We are encouraged by strength in automotive market, where revenues rose 24% on a 10% increase in volume. There are clear signs from auto manufacturers that semiconductor challenges are easing.
Apple’s ATT policy change caused advertising to begin declining. Inflation has accelerated that decline. Digital advertising is as easy to stop as flipping a switch, so it's the first to go when budgets tighten. It’s also likely to first to return when conditions improve.
The deceleration began with the platform policy changes implemented in Q3 of last year. Those policy changes upended a decade of advertising industry standards, and in turn, the model is used to drive the direct response to advertising business as well as the tools used to measure the returns from that direct response advertising.
And then beginning — later in Q4 and certainly through the first half of this year, we've seen macroeconomic challenges have built. While there have been lingering supply chain and labor supply issues impacting certain segments that began during the pandemic, more recently, we've seen the impact of persistently high inflation, then rising interest rates and rising geopolitical risks associated with the war in Ukraine. Those macro headwinds have disrupted many of the industry segments that have been most critical to the growing demand for advertising solutions over prior years…
They (advertisers) are taking this time, given all of those other macro pressures, to reevaluate their priorities to ensure that they're making the right investments in the right places. And when we talk about digital advertising, it is the easiest thing to turn off… it's also the first thing to get turned back on.
AutoNation is buying back a lot of shares.
During the second quarter, we repurchased 3.7 million shares or 6% of shares outstanding for an aggregate purchase price of $404 million. Further, we announced today that the Board of Directors authorized the repurchase of up to an additional $1 billion of AutoNation common stock.
Note: $1 billion is ~15% of Auto Nation’s market cap.
Precisions-scheduled railroading reduced UNP’s labor requirement, but the company is still struggling with staffing.
We run 1/3 fewer trains, which require 1/3 fewer locomotives and also 1/3 fewer people running the trains and maintaining the locomotives. So we took work out of the network that didn't need to be there because we were touching cars more than we needed to, and we had too many special commodity unit trains running around the network.
High fuel prices hurt railroads, but not as much as they hurt truckers.
There's a big fuel delta between rail and trucks. And so certainly, fuel has an impact on our margins, but it has an even larger impact in terms of that cost for people who are shipping by truck.
American Express — July 22, 2022
Although surveys suggest consumer confidence is at its lowest point in a decade, American Express cardmember spending is at record levels.
Revenues were up 31%, reaching a record high, and earnings per share were $2.57. Card Member spending was at record levels. Billed business was up 30% from a year earlier on an FX-adjusted basis, led by a vigorous rebound in Travel & Entertainment spending and continued strong growth in Goods & Services.
We're at 8% (spending) growth over 2019. And that's not really a big number when you think about it. When you think about 8% growth over 2019 from a T&E perspective, and you think about sort of airline prices, you think about some of the inflation built in, I'd say there's more room to run on T&E.
Bank of Hawaii — July 25, 2022
Bank of Hawaii’s deposits are sticky.
We also maintained our attractive and stable core deposit base with 94% of total deposits in checking and savings accounts. 92% of deposits are from core commercial and consumer customers and the remaining 8% in public deposits are predominantly government operating accounts.
The quality of our deposit base is further demonstrated by the longevity of our deposit relationships with our customers. Nearly 3/4 of our deposit customers have been with us for over 10 years and nearly half for more than 20 years.
Walmart has too much inventory and will discount it in order to sell it.
Food inflation is double digits and higher than at the end of Q1. This is affecting customers’ ability to spend on general merchandise categories and requiring more markdowns to move through the inventory, particularly apparel.
Canadian National — July 26, 2022
SE Asian imports and east coast port volumes are picking up.
We're seeing lots of volume shift over to Southeast Asia for production and for sourcing. And that's coming in — coming to the East Coast, just as easily as go to the West Coast. So we're seeing that diversion into the East Coast. And I think all the East Coast ports are seeing that.
US food and paper inflation is running 12-14% but improving. European inflation is worse, and worsening.
For the full year in the U.S., we expect roughly 12% to 14% inflation… On the labor side, we're probably seeing a little over 10% labor inflation right now.
Europe is getting hit harder on the inflation, certainly, on the food and paper…. different than the U.S., we don't see that moderating.
Air-conditioning is necessity, not a luxury, in the sun belt. This gives Watsco pricing power.
I wish I could read into what the consumer's mind is when it comes to the cause of a replacement of an air conditioning unit. It's unlike a car or any other staple that a consumer buys. It's something that — there isn't a list price out there that they can go ahead and match. There's not a consumer report that tells them what a price should be. And each job, as you recognize, is custom. And so it has different attributes and different issues that would affect the price to the consumer.
I think, particularly in the Sun Belt area, when it comes to the new products that we're going to be selling on the air conditioning side, it is a necessity. You're not going to live without it. So if you have to replace a unit, I think most consumers are going to find a way to be able to afford it and to do it.
And the same holds true with gas furnaces and heat pumps in the North and the Mid-Atlantic. Once again, if it's 20 below 0 in Alberta, Canada, you're going to be changing out your gas furnace in that market.
Debt issuance is likely to continue growing once companies adjust to higher interest rates.
Now debt issuance markets are clearly in a period of cyclical turbulence. However, we believe that the fundamental drivers of issuance remain firmly intact. And taking a medium-term view, we expect issuance to resume as capital markets adjust to a higher interest rate environment. And as you saw in the slides that we shared this morning, the volume of outstanding corporate debt in the U.S. has grown each year for the last 30 years, and we believe that the fundamental role of debt in fueling economic activity and financing business growth remains unchanged.
Americans are spending a lot.
In the U.S., payments volume index to 2019 was 146% in the quarter. U.S. debit volumes were 155% and credit 138% of 2019.
Visa is resilient to inflation.
Historically, in the U.S., we have seen PCE growth, which is the most important metric that drives our growth, remains strong even during inflationary periods.
People are likely to change making some changes on what they're buying. But… they're not changing how they're paying.
We don't have the same input costs and COGS as other businesses… Regardless of whether people are consuming differently or substituting one good for another good, they still need to pay for it and they're utilizing our services to do that.
Genuine Parts Company — July 27, 2022
High gas prices haven’t stopped people from driving.
Miles driven were up a little over 1% in May… And what we're seeing is an incredibly resilient consumer. We heard from our friends at AAA, 88% of travelers over the July 4 weekend, which gasoline was well over $5 a gallon in that timeframe. 88% of travelers were on the road in their vehicles. So as always, the automotive aftermarket is incredibly resilient.
GPC has a long track record of dividend increases, which speaks to the quality of the business and industry.
As a reminder, we have increased the annual dividend for 66 consecutive years.
E-commerce is reverting towards its pre-pandemic trends.
During the pandemic, we made a bet that retail spend would disproportionately favor e-commerce at a much higher pace than it has. Our belief was that the channel mix, the share of dollars that travel through e-commerce rather than physical retail, would permanently leap ahead. As we built for the digital leap, we stepped our efforts and we expanded the company accordingly. We couldn't know for sure at the time, but we did know that if the prediction came true, we would have to rapidly scale the company to meet that future.
Fast forward to now, as things have turned out differently. While the normalized rate of spend online, which is where most of our merchants orders occur, has reset certainly higher than where it was in 2019, the rate is lower than we had planned for. In short, we overshot our prediction.
WSJ columnist Jason Zweig call mean reversion the most powerful law in financial physics.
From financial history and from my own experience, I long ago concluded that regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.
Ben Graham understood mean reversion, which is why began Security Analysis with a timeless quote from Horace.
Many shall be restored that are now fallen, and many shall fall that are now in honor.
Old Dominion Freight Line — July 27, 2022
Old Dominion weights the cost of extra capacity with the benefit of the margin of safety is provides customers.
I think we're always sitting on idle capacity, and that's really what we want to have in place. And we generally target having 20% to 25% excess capacity at all times. And the reason for that is as quickly as demand can change, you can't put service center capacity in place quick enough…
And it's why when we see these positive inflections in the domestic economy that you see the rate of market share growth for us increased significantly where we're outperforming the rest of the group by double digits, if you will.
Old Dominion explains their capital allocation.
At the beginning of every year, we know what our CapEx is going to be. And then we've got the fixed return element through the dividend program and then we typically take the balance and try to put that into the share repurchase program.
Hilton has resumed its capital return program.
We expect to return between $1.5 billion and $1.9 billion to shareholders in the form of buybacks and dividends or approximately 5% of our market cap at the midpoint.
The new customers Etsy acquired during the pandemic spend more than pre-pandemic customers.
On a cohort basis, spend levels for all of our cohorts remain ahead of pre-pandemic levels as all of our buyer cohorts remain more valuable today than before the pandemic.
People are back to their pre-pandemic mobility.
We're almost at all the way back to the mobility level according to Google's mobility index that we were in Q2 of 2019, well before the pandemic. So people are out. They're dining out. They're shopping online. They are traveling.
A.O. Smith raised prices about 20% in response to inflation. Demand only slightly decreased.
Second quarter sales in the North America segment rose to $744 million, a 23% increase compared with 2021. Pricing actions largely on water heaters, represented approximately 89% of the increase.
85% of A.O. Smith’s business is replacement, which is non-discretionary. This gives them pricing power.
As far as the overall emergency replacement, that will always remain resilient. I mean people just don't go without hot water for any length of time.
Retail gasoline prices are quirky.
So during the month of April, our margins were more $0.26 in May. They're about $0.18, $0.185 and then June rebounded to almost $0.35 a gallon. The interesting thing that happened during the month of May was not that we had volatility in the market, but it has — because we still had a consistently rising market at that time, but it had to do when the price rises took place because 3 out of 4 weekends from the end of April through Memorial Day, the price rises occurred on Friday. And typically, the market does not like to restore on Friday. And so what that does is, it essentially freezes you in place at a lower margin than you anticipated. And in fact, that also happened Friday before Memorial weekend as well. And so that helped to contribute to industry-wide margins being lower in the month of May than they otherwise would have had those price increases happened during earlier in the week or middle of the week.
O’Reilly Automotive — July 28, 2022
Pricing in the aftermarket auto parts industry remains rational and is keeping up with inflation.
Our industry benefits from the reality that very little of the demand in the automotive aftermarket is truly discretionary and the necessary maintenance and repairs can only be deferred for so long. In fact, as economic conditions worsen, our experience has been that our industry provides even more critical.
We continue as a company and industry to rationally pass along inflation in pricing.
It's not a situation where if you lower the price on a category, the consumer is going to buy more of it. That's typically not the way it works. It's — the customer buys products from us because they have a problem and that purchase solves the problem.
First American Financial — July 28, 2022
The residential real estate market is entering a downturn.
Open orders were down 12% with June down 18% compared with last year. So far in July, this trend is continuing with open purchase orders down approximately 20% compared with last year.
Significant repurchases a continue. The board just authorized another $400 million for repurchases, 6.5% of FAF’s market cap.
Since the beginning of this year, we have repurchased approximately 6% of our shares outstanding as of the end of last year.
FAF benefits from higher interest rates.
We expect to generate $15 million to $20 million of annualized investment income in the title segment for each 25 basis point increase in the federal funds rate.
First Citizens BancShares — July 28, 2022
FCNCA announced a large buyback beginning August 1st to return excess capital.
We're excited to announce that our Board of Directors approved a share repurchase point, which will allow us to repurchase up to 1.5 million shares of our Class A common stock over the next 12 months, representing approximately 9.4% of our total common shares outstanding.
This particular repurchase is depending on price to take us to 10.6% at its conclusion.
Fresenius is struggling with labor in the US.
The unprecedented labor situation has been the most challenging headwind to date as many different aspects contribute to the dynamic problem. We continue to experience staff shortages, with open positions for our clinic staff increasing from around 7,000 to over 8,000 at the end of the second quarter.
While we continue to deploy many strategies for recruiting, this compounds our training costs. And we are experiencing a significantly higher-than-normal staff turnover rate for those new hires, and this is adding to the churn. We are mitigating the resulting shortage wherever possible with either available contract labor, which comes at substantially higher rates, or internally by deploying overtime and additional shifts that also comes with a premium and adds to the strain on existing employees.
The labor shortage is driven by retirements and nurses leaving to work in hospitals or at temp agencies. The situation is likely to “boomerang” back to normal.
We've had -- as you think about the great resignation, we've had people who are burnt out, they've retired and a number have just exited the workforce. And then I think the hospitals are also pulling on our labor pool as well.
So we've seen some of that shift where they're going into this hospital environment, which I would argue is more challenging, any environment than ours. But I think this pull on contract labor and agency labor and the rates that are out there, I mean, we're hearing kind of anecdotal, but like people are being paid $300 an hour just to kind of get into these agencies and contract environment.
So I think we'll see this churn. And as we started to see from Q1 to Q2, that maybe there will be the boomerang effect where we will get people back. But the talent acquisition team is doing a lot on the acquisition and retention of this, but it's clearly a challenge for us.
Inflation is high but abating.
Commodity and other inflation was mid-teens in the quarter, but we expect this to be a peak level as we anniversary inflation that began last year and we are beginning to see declines in certain input costs in the spot market.
Masco bought back a lot of stock.
This brought our total share repurchases to over $900 million for 2022 or nearly 7% of our shares outstanding at the beginning of the year. This likely completes our repurchases for the year as we will use our free cash ow to repay the $500 million term loan we used to fund the ASR.
Masco expects structural tailwinds.
We are on the edge of the large 75 million person millennial cohort forming households and entering the housing market. 2.7 million more homes will reach the prime remodeling age of 20 to 39 years old over the next 3 years. The COVID-19 pandemic has clearly increased the desire for more enjoyable living spaces, which has led to increased home demand and remodeling expenditures. And consumers and homeowners have strong balance sheets, with more than $2 trillion in savings and home equity values at all-time high. All of these structural forces provide tailwinds and for our repair and remodel business.
Chart is buying back a lot of stock.
We repurchased 7.2% of our fully diluted shares outstanding as of December 31, 2021, for approximately $7.8 billion.
The market misunderstands Wireless.
On the wireless, the -- it is increasingly important, and I don't think it's well understood by the marketplace. It has a reported EBITDA loss right now, but that's entirely driven by subscriber acquisition cost for sales and marketing. The EBITDA for wireless passed the positive point really some time ago. I don't remember what quarter, but it's probably a year plus.
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Frank - thanks for the comment. I think it's a little bit of both; we naturally gravitate towards these situations but there are a lot of businesses out there in general that are planning to repurchase a decent percentage of their float over the next year or so. Some of those decisions will turn out great and some may turn out very poorly if the business has a bad balance sheet, overpays for their stock, and/or is over-earning right now.
We are definitely attracted to businesses that are buying in a lot of stock as long as we're comfortable with both the price being paid and the predictability and underlying quality of the business.
Is it a quirk of the companies you follow or is everyone doing large amounts of stock buybacks? I'm seeing a lot of talk of "bear market rally" but if companies are buying back 5%+ of their float in the next year then it takes quite a bit of selling for the price to fall