The Weekend Edition #10

Welcome to the tenth issue of the Weekend Edition. 

Let’s grab a cup of coffee ☕️, while we take a look at what happened in the markets this week. 

Here’s what we cover:

• Market Recap - a look at the major indices

• The FOMC Meeting - Recap

• Earnings of Week - Darden Restaurants, Adobe and Nike in Focus

• Around the Market - Disney, Salesforce and Cryptos

• The Week Ahead - Infrastructure Bill and the Debt Ceiling

• Closing Thoughts - Debt Ceiling debate = Volatile Market

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Market Recap - 20 Sep 2021 to 24 Sep 2021

It was brutal Monday opening for the US stock markets with Dow opening +600 points down from Friday’s closing. Not to mention the Hang Seng Index dipped 3% earlier in the day after Evergrande and other Chinese Developers saw their stocks slide further.

The ripple effect spread to the US markets as people seemed to think Evergrande’s default would cause a contagion and the common question was whether this was China’s Lehman moment. It is not!

[My two cents on Evergrande… The PBOC has already pumped liquidity into the economy in anticipation of a crisis and the regulators have warned Evergrande about defaulting on their debt. The company has already hired restructuring experts. The unfinished apartments (+1.6M) will likely be finished by Evergrande or other developers and there will be some kind of Government support for this, so consumers don’t lose their money.

It’s the debt holders who will suffer, getting locked into a restructuring proposal, ultimately receiving 30 cents on the dollar for their debt if the government decides to let Evergrande go into administration. It will be a drawn out process. But the bottom line is, the situation will not cause a systemic downfall crashing the global markets.]

Back to the markets… Come Wednesday, we had the FOMC meeting and stocks rebounded. Markets still remained subdued in certain sectors as the US10Y yield jumped to 1.456% on Thursday from Wednesday’s close at 1.304%. As US30Y increased, the real estate market took a slight beating.

The FOMC Meeting

No tapering announcement this time! Like we didn’t see that coming… I think there was some confusion but, the odds were against it. However, tapering will begin “soon”, and Fed Chair Powell was clear that this language indicates that an announcement could be made as soon as the next meeting - Nov 2 - 3. There were also few other important comments:

1. The timing and pace of tapering - Fed Chair Powell said that they would target mid-2022 to end the tapering program which means about 6 months, which is relatively quick. [2013-2014 tapering was 10months]

2. He also noted that the government balance sheet still remains elevated enough to “support accommodative financial conditions”

3. The Fed Funds rate will be maintained at the current level of 0-0.25% and tapering should not be signal any kind of rate liftoff.

4. The dot plot shows and he confirmed that half of the FOMC participants forecast conditions for rate increase by the end of next year, i.e., 2022.

5. There was no mention of inflation being “transitory”. In fact, this time Chair Powell acknowledged that “inflation is elevated and will likely remain so in coming months before moderating”. Median projections from the participants show inflation falls from 4.2% this year to 2.2% next year.

Even after the indication of the relatively fast pace, bond markets remained relatively calm with only a slight uptick in yields. Last time, when the Fed decided to taper at the end of 2013, it was done in 10 months and there was definitely a tantrum which sent yields soaring and hit the housing market hard.

It may be too early to tell, but there doesn’t seem to be much sign of a tantrum. This is quite possibly because the market sees any rise in bond yields that may cause pressure on stock prices, to be balanced out by the positive growth from the re-opening of the economy.

Earnings of the Week

Five diverse companies reported this week, all with something important to say. We look at highlights from two and then dive into Nike a little more in detail, not only because it happens to be one of my favorite companies, but also because it is a classic example of how the supply chain disruptions are playing out.

Darden Restaurants ($DRI)

• Q1 blended same-restaurant sales up 47.5% 

• Q1 same-restaurant sales by segment on YoY basis:

  • +37.1% for Olive Garden;

  • +84.6% for Fine Dining;

  • +47% for LongHorn Steakhouse;

  • +65.8% for Other Business

• Purchased $186M of shares during the quarter and announced another $750M

• Raised FY22 same-restaurant sales vs. FY21 to 27%-30% from 25%-29% 

• Raised FY22 diluted EPS view to $7.25-$7.60 from $7.00-$7.50 

• Raised FY22 revenue view to approximately $9.4B-$9.6B from $9.2B-$9.5B,

The numbers were fantastic and now that the economy is heading back to normal, the Company, we can only expect better. The CEO however, did report increases in costs and sees inflation in their inputs at about 4%. They’re also wary of the labor shortages. But, they’re not keen on raising their prices because they want to maintain their “value for money” status.

The stock soared on earnings from $150 to $164.28 (+9.5%) before settling back down to $158.70 at the end of the week. I think we see the stock settling around $155.

Adobe ($ADBE)

• Beat on Q3 EPS and Revenue estimates.

• Q3 ARR up $455M from Q2 to $11.67B 

• Guided Q4 EPS $3.18, consensus $3.08, Q4 revenue $4.07B, consensus $4.04B

• Forecasts: Digital Media segment revenue up 20%, Digital Experience segment revenue up 22%, and Digital Experience subscription revenue up 26% from last year in Q4

Despite, the strong results and guidance, the stock sold off by $20, and is down -4.85%, closing at $$622.71 for the week. The Street however, raised price targets across the board and the average PT is now $646.31.

Nike

I’m clearly biased when it comes to Nike, but I have to say that the earnings call was so direct! The CFO, Matthew Friend, was clear with timelines and details of the supply chain disruptions. Despite the supply chain woes, Nike made significant strides in innovation and took home 226 medals, including 85 golds, in the Olympics.

First let’s look at the results:

• Diluted EPS $1.16 vs. $0.93 for the previous quarter (+24.7% QoQ)

• +16% YoY Revenue Growth; +25% growth in digital; +24% Nike owned stores

• N. America +15%; China +1%; EMEA +8% and APLA +31%

• Repeat buyers +70%; 65% full-price realization

• Digital is now 21% of the Nike brand revenue and the target is to get to 40% by 2025.

• Gross Margin +1.7% YoY; SG&A expenses +20% YoY

• Revised guidance downwards to mid-single digit growth for FY22 vs. low double-digit guided previously

• Supply chain issues to normalize in FY23

Clearly, Nike will be in some trouble for the next three quarters. The shutdown of factories in Vietnam and Indonesia due to Covid has caused worse-than-expected disruptions. They’ve lost 10 weeks of production starting mid-July in Vietnam, where 80% of their footwear factories and nearly half of their apparel factories remain closed. Indonesia is back up and running but, ramping up production will also take time. What’s the net effect:

• Longer lead times - e.g., for N. America lead times have doubled to ~80 days.

• For N. America, there’s still a higher level of in-transit inventory which means that the fall orders will get fulfilled in Q2, but the holiday and spring orders will likely not meet the higher demand in Q3.

• For China and AP, the situation is worse because they hold lower inventory levels since the lead times are shorter. So supply shortages will start in Q2. The low growth in China was attributed to Covid shutdowns during the quarter. There was no mention of the effect of their stance on the labor conditions in Xinjiang.

• The phased opening of the factories in October, will like mean 14-16 weeks of backlog until production is ramped up. Production is being moved to factories in China or other parts of the world, particularly apparel to mitigate these issues.

• Cost pressures will remain. Nike has increased product prices by less than 5% to cater to some of this but, still has to absorb much of the increase. The management believes the Company’s financial standing is strong enough to weather this.

How Nike manages the next few quarters will be crucial but, it’s not like they haven’t had their fair share of troubles in the past. The way the company pivoted to digital as the pandemic unfolded was commendable and in the long-run, the Company’s strategy remains solid.

Around the Markets

We’ve already covered a lot this week, so I’m going to make this brief:

• Disney ($DIS) took a -3% fall earlier in the week, as CEO Bob Chapek presented a gloomy picture at the Goldman Sachs conference. He said that the company was experiencing production delays for Disney+ and that Global paid subscribers will increase by low single-digit millions vs. Q3. For reference, Q3, subscribers grew by almost over 12million (+12%).

• Salesforce ($CRM) held their annual Dreamforce conference during the week and coincidentally, raised their revenue outlook for FY22 by $50M but also raised FY23 revenue outlook by $330M at the higher end. Shares hit an ATH of $286.36 on Friday, with analysts raising price targets across the board.

• Zoom ($ZM) is facing heat because of their servers in China, by a US Justice-department led committee called “Team Telecom” over their agreement to buy Five9 citing “potential national-security risks posed by the videoconferencing giant's China ties”. - WSJ. 

• China banned Cryptocurrencies yet again on Friday sending prices downwards. According to Bloomberg: “The People's Bank of China announced that transactions in all cryptocurrencies, including services provided by offshore exchanges to domestic residents, are illegal financial activities”. This isn’t the first time that the Chinese authorities have cracked down on crypto and it certainly won’t be the last.

The Week Ahead - Sep 27 - Oct 01, 2021

We have two relatively quiet weeks ahead with fewer earnings reports before we kick off yet another Earnings season in the second week of October, starting with the Banks.

Here are a few more dates that may potentially cause volatility in the markets:

• Monday Sep 27 - Nancy Pelosi has promised to hold a vote on the $1 trillion infrastructure bill.

• Tuesday Sep 28 - Fed Chair Powell provides testimony on Coronavirus and CARES Act at 10am ET

• Wednesday Sep 29 - Fed Chair Powell holds a policy panel discussion at 11:45am ET.

• Wednesday Sep 29 - Warby Parker Direct Listing ($WRBY)

• Thursday Sep 30 - the day by which Congress has to pass a funding plan to avoid a Government shutdown. If raising the debt ceiling is included with the funding plan vote, there may be opposition on the entire vote and come Oct 1, the government shuts down.

Closing Thoughts - Debt Ceiling

What’s going on with the debt ceiling? Well, the Government has had to borrow to fund all the stimulus and money they’ve pumped into the economy. This increased the debt and every time this has happened in the past, the debt ceiling has either been suspended or raised. And now the US Treasury faces the situation again. But, what’s causing the problem is that the debt ceiling issue is being tied to the spending bill and there’s a political standoff.

The Street consensus is that the US Government runs out of money to pay their bills sometime between Oct 15 and Nov 04. So if the debt ceiling is not raised in time, the Government falls short of about $500B to meet their payments.

Most experts are confident that the ceiling will be resolved, and there will be no default, but it’s a race against time because the process takes about three weeks, and officials may be cutting it too close.

What does this mean for the markets? Watch out for choppy trading as this issue comes to a head on Thursday. 

Here’s wishing you a happy weekend and safe investing. 

Please take a moment to share and subscribe, if you found this newsletter useful.

Sincerely yours,

Ayesha Tariq, CFA

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 a long position in $NKE, $DIS, $FB, $COST, $DRI as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.