46. Bouncing back
963 words (4-minute read)
Q1 earnings season is rolling.
I love earnings reports—companies let us know how they’re doing and help us piece together the economy. They provide evidence of what’s passed and clues of what’s to come. They are scorecards, snapshots, and signals.
Q1 earnings are coming in hot—we got a whole bunch of them this week.
Here are a few takeaways:
Numbers look especially good when their comparison points were bad. This Q1 marked the anniversary of pandemic lockdowns. For a lot of companies, 1Q2020 reports started to look bad because everything was shutting down. When you compare YoY to a bad quarter, you get high percentage increases. Normally, those high percentages would mean strong growth, but this quarter was anomalous in that part of the growth was just things getting back to normal (we can expect this effect to be stronger in Q2).
Beware of goodwill. PG, the “global leader in the fast-moving consumer goods industry,” is worth over $300B in the marketplace. It has $116B in total assets—$40B of that is goodwill. PG’s report contains one of the more extensive discussions of goodwill accounting that I’ve seen—probably because they own every brand under the sun (Head & Shoulders, Old Spice, Venus, Gillette, Crest, Dawn, Mr. Clean, Pampers, Tampax, Bounty, Charmin, etc.). Most of their goodwill reporting units are “comprised of a combination of legacy and acquired businesses,” which have “fair value cushions” that exceed at least 2x their carrying value (meaning goodwill is not in question and actually underestimates the unit’s value). However, some units are “comprised entirely of acquired businesses” and therefore do not have as much of a cushion. In particular, “the Gillette indefinite-lived intangible asset,” which is carried at $14.1B, is “the most susceptible to future impairment risk” (PG 8K, pg. 11). PG is hoping Gillette doesn’t end up like Coca-Cola’s (KO) Odwalla brand:
“During the three months ended March 27, 2020, the company recorded an impairment charge of $152 million related to our Odwalla trademark, which was primarily driven by revised projections of future operating results due to reduced availability at retail customer outlets and a change in brand focus in the company’s portfolio.” (KO 8K, pg. 13)
Inflation continues to rear its head. Last week, we talked about the fact that the Fed hasn’t budged in response to inflationary indicators. Earnings reports continue to provide evidence of inflation. PG’s increased prices contributed 2% net sales growth. In addition, the company’s “overhead costs as a percentage of net sales increased 20 basis points primarily due to inflation and other cost increases” (PG 8K, pg. 19). Inflation is natural and desirable—to an extent. Time will tell if it’s becoming a problem. In other countries, inflation is a problem—KO credits its Latin American sales jump to price increases:
“Price/mix grew 7%, driven by pricing in the marketplace including inflationary pricing in Argentina.” (KO 8K, pg. 4)
Growth expectations aren’t always met. Netflix (NFLX) has been (and will continue to be) the object of high growth expectations for a long time. After reporting earnings on Tuesday, their stock dropped about 7% the next day. Why? Because they added only 4M subscribers and revenue grew only 24%. They had forecasted 210M paid memberships for this quarter, but ended with only 208M. Investors got nervous, but NFLX remains long-term confident and expects to spend $17B on content by the end of this year to continue delivering “best-in-class” and “great, locally authentic” stories:
“We believe paid membership growth slowed due to the big Covid-19 pull forward in 2020 and a lighter content slate in the first half of this year, due to Covid-19 production delays. We continue to anticipate a strong second half with the return of new seasons of some of our biggest hits and an exciting film lineup. In the short-term, there is some uncertainty from Covid-19; in the long term, the rise of streaming to replace linear TV around the world is the clear trend in entertainment.” (NFLX 8K, pg. 1)
We still love burritos. Chipotle (CMG) sales jumped 23.4% to $1.7B last quarter (compared to 1Q2020’s 7.8% YoY increase). Digital sales continued to go crazy, accounting for a majority of total sales. Customers love the digital moves CMG is making—we like ordering ahead online and picking food up quickly:
“Digital sales grew 133.9% year over year to $869.8 million and represented 50.1% of sales. A little more than half of the digital sales were from order ahead transactions as guests increasingly appreciate both the value and convenience offered by this channel, as well as the added convenience of more Chipotlanes.” (CMG 8K, pg. 5)
Pantry loading is an official term. Johnson & Johnson (JNJ) and Procter & Gamble (PG) both pointed out the fact that Americans’ pantry habits have been notably different during the pandemic. JNJ’s Consumer Health segment sales declined 2.9% YoY mainly because 1Q2020 sales were inflated due to “pantry loading… mainly in over-the-counter products” (JNJ 8K, pg. 6). Over at PG, net sales increased in every segment (Beauty; Grooming; Health Care; Fabric & Home Care; Baby, Feminine & Family Care)—again, in part thanks to pantries:
“We have experienced a significant increase in demand and consumption of certain of our product categories (fabric, home cleaning and hygiene products) primarily in North America, caused in part by changing consumer habits, pantry stocking and retailer inventory replenishment, due to the COVID-19 pandemic, contributing to increases in net sales, net earnings and cash flows.” (PG 8K, pg. 18)
The real question is… is it pantry loading or pantry stocking? That’s a debate that needs to be settled.
@James in CA—I think I know where those CMG digital sales are coming from…
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I’d love to hear your thoughts and stories. If you have anything to share, or if there are any topics you’d like to hear more about, please email me at tucker@prevailingwinds.co.
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