Just when we thought the Philadelphia market had started to stabilize, our visit last week showed that competitors (particularly Albertsons’ Acme banner) have been pulled back into an aggressive promotional strategy. With food input costs up as was seen in the latest PPI release earlier this month, the deflation we continue to see in most of the markets we visit on our fast turning/high household penetration basket of consumables suggests that margin pressures are likely to mount, at least in the short-run. This is especially true as companies also deal with rising wages and high employee turnover. As such, we continue to believe that the current operating climate is very challenging for both Food and Broadline Retailers. If there is a little bit of hope for the industry it is that the strong economy is helping demand as many companies have seen a pickup in sales since early June. And while the secular industry challenges remain daunting, if the better volume trends are sustained or even accelerate, this could potentially lead to some lessoning of the competitive climate. Although this is more conjecture than reality at this stage as most of our surveys have deteriorated at the margin.
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The dog days of summer. It’s a quiet but perfect time to catch up with CHK, a company and management team we really like, but with a mountain of debt the driver of corporate direction, it’s a tough stock to recommend and subsequently has fallen out of most conversations with equity investors. Asset improvement, margin expansion, and debt reduction are all on management's to do list right now and not that every other producer isn't focused on these, but CHK's plate is full with a lot more than most to tackle. Without higher commodity prices as a life line to count on, more aggressive action may be needed to get investor conversations perking up again and we hope they do as OKC trips are a lot more fun when times are good at CHK. We know they are up to the task, but we remain Peer Perform.
This morning (7/26/17), Ford reported Q2 and met on Revenue but Adj. EPS of $0.56 was above consensus of $0.43 and our $0.38 with $0.13 of help from taxes. Revised full-year guidance implied a small cut even at the high-end of the range by our round math (Exhibit 2) as commodity costs, and warranties were cited. Shares were down -2%.
We believe risk/reward is less attractive relative to the rest of our Capital Goods coverage given persistent negative trends in the Hydratight business in Energy as customers structurally stretch maintenance cycles – which helps to explain why process automation suppliers have outpaced physical maintenance: it’s not a complete lack of spending, it’s optimized maintenance vs. a history of over-maintaining. Management wants to get deeper in this space, which we view as suffering from overcapacity. The Viking sale is a clear positive, largely reflected in prior valuation, but there’s still too much time spent on Energy. A catch-up in Enerpac investment and mature growth in Euro/China truck limit upside.
CPN announced a sale of the company for $15.25/sh in cash ($5.6B in total) – a 51% premium to the unaffected May 9th price prior to reports of the sale process. Energy Capital Partners (ECP) is the buyer along with Access Industries and Canada Pension Plan, the latter of which will invest $750M. The deal is targeted to close in 1Q18 with approvals needed from the DOJ, FERC, NY PSC, and PUCT. We do not see material asset overlap between ECP and CPN that would cause market power issues. The deal is not contingent on financing and Moody’s and S&P affirmed ratings, though Moody’s moved to negative outlook. Mgmt. is expected to remain in place.
For the period after Labor Day (Sept-Dec), aggregate system seat capacity moved down again falling 10bp to +4.0% y/y. Domestic seat growth fell 10bp to +3.8% y/y from trims by a couple carriers including AAL, DAL, JBLU and ALK, though offset slightly by increases from UAL. International capacity ticked up 10bp w/w to +5.2% y/y due to UAL and JBLU adding slightly in Latin/Caribbean. Remember, week-by-week trims happened just like this last year and it set up for a nice 4Q. The market seems to be suggesting airlines have no control of anything.
It was a busy week on the geopolitical front, but a pretty quiet one for transports, so we’ll keep it short and sweet this week. Overall, our WR Transport Index was basically flat last week (+0.1%) but outperformed the S&P 500 which fell for the second week in a row (-0.6%). Most notably to us, TL stocks increased 1.6% last week, and they’re now the best performing freight sub-sector in the group. On the other hand, LTL stocks (-1.8%) were the worst performers last week.
The premium on revenue growth and sound capital allocation continues to grow and the nuance of who can perform well in a difficult environment is lost at the moment. This will undoubtedly act as a throttle on OP-rated AYI, AXE, and WCC, although we believe risk/reward is sound from here. Investors aren’t cyclically constructive from what we can tell and we spent more time on secular automation nuances in CGNX (OP) and ROK (PP) than debating a cycle. Value focal points continue to be PP-rated JCI and FLS, but with very little sense of urgency.
We spent the earlier part of last week with clients & managements in Denver for the Enercom conference. Our high-level takeaway was that while management teams are for the most part defending, and even exclaiming, operational performance, investors are simply looking for more. We think especially, in the way of balance sheet & restructuring catalysts. Our most positive meeting was with Advantage Oil & Gas CEO Andy Mah – he crushed it. Andy presented a lower-risk, lower-capital-intensity strategy focused on delivering mid-teens production growth while allocating free cash to debt pay down and cash return to shareholders. The strategy is refreshing and hopefully what the larger Marcellus producers ultimately pursue. We also got some clarity from Cimarex on its (and Devon’s) anticipated Jacobs Row Woodford pilot. Cimarex is taking its time regarding this Jacobs Row thing, as it has two Woodford infill pilots, results from which it would want to analyze, before spudding its operated section of Jacobs Row. The other takeaway from our meetings was a focus on the Permian, which will clearly be the spotlight of 3Q17 earnings season. PDCE, QEP, and XEC were the companies who presented for us with Permian exposure, and while all were bullish on operational performance, investors remain skeptical. Everyone dismissed gas-oil ratio as a known problem, indirectly indicating that Pioneer may have unique problem. We keyed in on PDCE difficulties in its Western Delaware Basin acreage for example, while completely skipping over outperformance from its Kenosha extended lateral well in the eastern portion of the acreage, the eastern Delaware will be the focal point of spending at least near-term.
This is our third report in our summer valuation series (click for The Intersection of Valuation and Cyclicality and Are Current Valuations Sustainable?). This week, we focus on seven lessons we’ve learned from analyzing stock picking strategies and debunk some common misperceptions.
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