The Weekend Edition #3
Where is the Economy heading? Cruise Lines ($NCLH; $CCL$RCL); Retail REITs ($SPG; $KIM; $FRT) $GM, $CLX; $SQ and Afterpay; Archegos, and more...
Welcome to the third issue of the Weekend Edition.
Grab a cup of coffee ☕️, and relax while we take a quick look at what happened in the markets this week. This week we cover:
Market Recap - with Macro views from Howard Marks, Goldman Sachs and Citi
Sector Updates - Large Caps, Retail REITs and Cruise Lines
The Real Deal - A brief look at Square’s acquisition of Afterpay
Market Snippets - other news from around the Markets
Let’s dive in ⬇️
Market Recap - 02 Aug 2021 to 07 Aug 2021
The markets remained mixed this week, with more emphasis on Covid and the Delta Variant. Regulations for masking and vaccinations increased, including more companies requiring employees to be vaccinated before they return to work.
We saw some price action yesterday, when the Jobs Data came out. Jobs climbed 943k in July with a net 119k in upward revisions to May and June. The unemployment rate dropped to 5.4% from 5.9%. Earnings increased 0.4% and accelerated to a 4.0% YoY.
This positive data supports the probability of the Fed starting to taper later this year and caused the US10Y rate to spike to 1.3% on Friday. The Financial Sector benefited as we saw Goldman Sachs ($GS) and Morgan Stanley ($MS) hit all time highs on Friday.
Where is the Economy heading? Where are the Markets heading? These seem to be the questions on everyone’s minds these days and most of the answers are all conjecture.
Last week, I’d written that Goldman Sachs’ (GS) consensus was that the S&P could rise another 6% till the end of the year. This Thursday, GS revised their consensus upwards expecting the S&P 500 to close at 4,700, from the previous estimate of 4,300, implying a 7% increase. While Citi suggested a 10% correction in the market because inexperienced investors were ploughing their money into speculative tech stocks.
GS also raised its probability of the Fed tapering to 25% from 20% in November and 55% in December. The Fed has three more meetings in 2021: September 22, November 3, and December 15 and there are two Jobs Reports out before then. If the Jobs numbers are strong, the likelihood is that we may start to see some tapering resulting in higher rates, which in turn will mean pressure on growth stocks.
Again…. all of this is “guesswork” for lack of a better term. And this is where I think Howard Marks has a brilliant writeup. In his latest Memo, titled “Thinking About Macro”, Marks makes the excellent point that while Macro signals are important, they are not knowable. [I’d urge you to read the memo. It’s 15 pages long but a quick read].
Most people cannot predict the future with any degree of certainty, let alone macro economists. Marks goes on to explain the state of the economy and draws on lessons from history saying, the US has run a large and growing deficit for more than 20 years and markets still underperformed during 6 of those years. He draws the conclusion that today’s asset prices are not irrational relative to rates and that while there is a possibility of higher inflation, he thinks investors should “not significantly invert asset allocations in response to macro allocations”.
If you still want to learn about Macro Investing or Trading, I’d suggest looking into Hedgeye. They have an interesting methodology and it seems to work well for many. Here’s a Cartoon from Hedgeye which seems to sum up my thoughts perfectly.
Sector Insights - Large Caps, Retails REITs, Cruise Lines
Large Cap - Supply Pressures
This was a terrible week for $GM and $CLX, with their stock prices plummeting 10% on average, after their earnings came out. The culprit… Supply Side Pressures. Both companies experienced supply chain difficulties, rising costs and not being able to manufacture enough units. For Clorox, demand on professional cleaning supplies has also decreased, much more than expected.
The stars of the re-opening plays this week were the Retail REITs. All three - Simon Property Group($SPG), Federal Realty ($FRT) and Kimco ($KIM) reported excellent numbers. Federal Realty, increased their dividend yet again, maintaining their Dividend King status. SPG also raised their quarterly dividend and raised FY21 FFO view to $10.70-$10.80, consensus $9.84.
While occupancy improved across the board, all three REITs also saw an increase in new long-term leases signaling that retailers are hopeful of a sustained recovery. While stock prices surged for all three, $SPG remains the most solid play.
The Cruise Lines all reported hopeful numbers. Norwegian Cruises expects to turn cash flow positive by 1Q2022 and have seen a massive rise in their booking numbers despite the Delta Variant. They’ve put in stringent measures to ensure that only vaccinated passengers board their ships and only after negative Covid tests. They have isolation areas and makeshift ICUs on board as well. They claim that their cruise ship should be the safest place on earth after all the measures they’ve taken. Share prices are still hovering around the $24s.
Carnival on the other hand hasn’t had the same luck. Even though their crew is fully vaccinated, they just found Covid positive cases on board, despite taking stringent measures. This will not bode well for the cruise lines and it remains to be see how the travel stocks recover. Still, I admire how these companies have managed their balance sheet during this time of crisis, restructuring debt to bring down borrowing costs, and managing cash burn at acceptable levels. I’m long $NCLH.
The Real Deal: Square buys Afterpay for $29B
The news of the week was definitely Square ($SQ) buying Afterpay for $29B in an all stock deal and they pre-announced their earnings on Sunday night to coincide with their acquisition announcement. Needless to say, the deal was seen as a positive along with SQ’s own EPS beat of $0.66 (est. $0.30), which sent the stock price soaring. I’m long $SQ, because I’m bullish on the company’s ability to bring fintech to the masses.
Afterpay is an Australian-based “Buy-Now, Pay-Later” (BNPL) provider founded by Nick Molnar and Anthony Eisen. The company has had an impressive level of CAGR of 92% in Revenue and 105% in Gross Merchant Value over 2019-2021 expanding across Australia, New Zealand, the UK and the US. Afterpay gets a sweet stock deal of of 0.375 shares of $SQ class A common stock for each of their ordinary shares and the co-founders get to stay on.
For Square, the benefits are immense:
Integration into their Cash App, allowing users to use the 4-month BNPL feature
Integration into the POS systems allowing their merchants to offer BNPL
Entry into markets where Square doesn’t have a footprint
Afterpay’s TTM Gross Profit as of Jun 2021 was USD 502M (96% YoY growth) and is expected to deliver significant upside growth
Two snapshots from the transaction which sums it up nicely:
Is Square paying too much for Afterpay?
The Market certainly doesn’t think so as you can tell from the surge in stock price, which is unusual for an acquirer. But, neither does Wall Street. $SQ got multiple upgrades post their earnings and merger announcements.
Credit Suisse Group announced that they had hired the law firm of Paul, Weiss, Rifkind, Wharton & Garrison LLP to conduct a comprehensive review of CS’s relationship with Archegos following the US hedge fund’s default on March 25, 2021. The report is a fascinating autopsy of what happened. In summary, the Bank’s risk policies and procedures were not at fault but rather an oversight on the part of the relationship team. In their zeal to keep the customer happy, the relationship team did not enforce or may be could not enforce the higher margin requirements suggested but the Bank’s risk management committee. CS has already made changes to the Investment Banking and Risk Management teams, stressing that there was no instance of fraud… just plain negligence. Matt Levine’s Bloomberg Opinion piece titled “Archegos Was Too Busy for Margin Calls” is well worth the read on this one.
Infrastructure still in Play
The U.S. Senate is heading toward a weekend vote on President Joe Biden’s $550 billion infrastructure legislation, according to Bloomberg. Earlier this week, the “Infrastructure Investment and Jobs Act” was released. The largest item on the agenda was $110B for roads, bridges, tunnels and other major infrastructure projects. Another $66B for rail, $39B for public transit, $25B for Airports and $17B for ports and waterways. This could mean potential upside for a number of infrastructure stocks starting with the materials sector. ⬇️
Berkshire Reports 2Q2021 Earnings
As l write this, Berkshire Hathaway ($BRK-A; $BRK-B) has just released second quarter earnings for the year. They always report over the weekend. Net earnings rose 7% over the quarter to $28.1B ($18,488 per BRKA shares) compared to $26.3B for the same period last year, on the back of increased business from railroads, utilities and energy. Profits for the insurance arm decline, while manufacturing, service and retail showed a remarkable improvement compared to the decline during the pandemic. Many of it’s business in these segments now exceed pre-pandemic levels. The company made share buybacks of $6B over the second quarter, spending a total of $12.6B in the first six months of the year. Quarter ending cash balance held was $144.1B at the end of the second quarter down from about $145.4B at the end of the first quarter. I’m long $BRK-B.
Did we learn anything about where the Market is heading? Well…
It reminds me of the weatherman on TV when I was young who’d say: “There’s a chance of rain tomorrow… or not”.
We can only invest the best we can with the information we have. Investing based on Macro Signals is tough, and rife with the possibility of failure if you can’t do it right. Sticking to fundamentals and sectoral analyses may serve you better.
Let me leave you with a quote:
“an economist is a portfolio manager who never marks to market” - from Howard Marks (Oaktree Capital Management, LP)
Here’s to a great week in the markets ahead…
Ayesha Tariq, CFA
Remember, there’s always a story behind the numbers.
None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have no affiliation with any of the companies that are mentioned.