In this episode, we discuss the softening trends picked from Q1 earnings calls, the impact of First Republic Bank’s demise, and double-digit revenue growth for consumer packaged goods companies.
The episode is based on yesterday's newsletter which is available on Substack.
A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.
Show Notes
00:00:00 Introduction
00:00:08 Softening Trends
00:01:23 The Impact of the End of First Republic
00:04:46 What will the Fed Do?
00:06:55 Price-Driven Growth
00:08:38 Takeaways from Tech Earnings
00:11:15 Conclusion
Transcript
Introduction
[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of the Transcript, along with Erick Mokaya, who's our lead author.
Softening Trends
"...we are seeing a slight decrease in units per transaction. So, things like did someone add fries to their order, how many items are they buying per order, we're seeing that go down in most of our markets around the world slightly, but it's still going down…we are seeing, in some places, resistance to pricing, more resistance than we saw at the outset. So I think all of those things are reflective of, again, a more challenging macro environment." - McDonald’s (MCD 0.65%↑) CEO Chris Kempczinski
We sent out a new issue of the newsletter yesterday and what we were seeing in a big week of earnings. We saw some softening trends in the macro economy and the consumer starting to deteriorate a little bit. We saw people talking about the freight recession again, which has been ongoing for a while. And we saw some indications that even credit card delinquencies were starting to rise from Capital One. Just all of the things put together look like the economy continues to slow a little bit. So we titled the newsletter Weakening Trends this week. Erick, any thoughts?
[00:00:44] Mokaya: I agree. I think the sense of the data that we have, or at least from the earnings transcripts is mostly to do with softening trends. They're not crushing, but slowly you can feel like from the time we've been reading the Q4 earnings calls to now we are reading the Q1 earnings calls, it's been a slow and steady going down. So not a rapid fall off the cliff I would say given the event of the banking crisis in March, but still decline. That's what we're seeing. Inflation is declining. And lower inflation of course means a bit of lower top-line growth for some of the companies that we're following, especially the fintechs and the financials.
The Impact of the End of First Republic
But outside that, I think the key thing last week was mostly the big takeaways from big tech. But before we go to that we should discuss a bit of the banking crisis that we are again pulled back into with the recent developments in First Republic. Any thoughts on that?
[00:01:41] Scott: I think before we went into earnings season, you and I talked about First Republic being the earnings call of the entire season, the one to watch, and it did not disappoint. First Republic reported its earnings from the first quarter and five days later, it's no longer a walking organization, a going concern on its own. Actually, I think one of the things that was really noteworthy to me about the First Republic staff was that they didn't take any Q&A on their earnings call. And I feel like that felt like they had something to hide because of that. I wonder if they had been a little bit more transparent with the dynamic that was going on if they could have avoided this second phase of the bank run for themselves. Because, underlying, they lost most of their deposits in the March timeframe. And then actually they were talking about how deposit outflows had more or less stabilized for them. So they were a little bit more stable until they weren't stable anymore. And this goes back to what has happened in this entire banking crisis. And going back to the financial crisis, the regulators just acted really quickly and forcefully. If it looks like a bank is going to fail, they will make sure that it does fail. Basically, they will make sure that it closes shop before anything contagious could happen. But, I don’t know. What are your thoughts, Erick?
[00:02:55] Mokaya: To add to that is mostly like the takeaway from their earnings call simply said that deposits were stabilizing. They had a lot of deposit outflows in March but from the beginning of April to the date when they reported earnings it was only like a 2% decline, which was very small. So the takeaway from the earnings call, they kept saying the word stabilizing, but then the whole week, and mostly because they didn't take the Q & A section so that people can allay their fears, all the talk was about this bank is going to fail. Then eventually it fails.
“Our government invited us and others to step up, and we did. Our financial strength, capabilities, and business model allowed us to develop a bid to execute the transaction in a way to minimize costs to the Deposit Insurance Fund” - JPMorgan Chase (JPM -1.59%↓) CEO Jamie Dimon
So now JP Morgan has taken over the bank. So it looks like quite tough times ahead for the smaller banks. If any of these small banks does fall into a tough time, they definitely will be taken over by the big banks, which is a bit of a sad situation to be in because I've enjoyed First Republic’s earning calls for the longest time possible. I've enjoyed SVB also, but now they're both gone and they served a very important part of the economy. Do you think the customers will miss them now?
[00:03:56] Scott: I think the customers will definitely miss them. I think that the true impact of these two banking failures has not totally been felt yet fully, and unfortunately as a Californian, I feel like California and the startup economy are two of the areas where credit will actually end up tightening most severely. High-end real estate mortgages in California, First Republic probably had a pretty large share of that. And then SVB, their client base, obviously in the startup ecosystem, they were the largest bank in town for that. And JP Morgan does not have the same underwriting standards that those two banks had with those client bases. So there will be restrictions on the amount of credit availability. I think it's a net negative for California as a local geography.
What will the Fed Do?
[00:04:46] Mokaya: And then this is Fed week by the way. So last time they were having the Fed meeting, it was just before the banking crisis. And once again, just before this one, there's another banking crisis. So I don't know how the Fed is going to incorporate some of this data. So from our transcript, of course, economic conditions seem to be weakening and credit conditions should be tightening. And at the same time, we have a little bit of a banking crisis all around which. The crisis around First Republic has been resolved, but generally, there's a bit of worry around deposits and deposit flows in the economy and how loan growth is going to be. Whether some parts of the economy are going to be starved off loans and mortgages going forward. So quite a bit of work to do in Jerome Powell’s hands this week. All attention is on him and the FOMC. Any thoughts on that?
[00:05:36] Scott: Yeah, I think what they're signaling is that they'll raise rates again, most likely, and then they may signal at this meeting that they're gonna pause raising rates going forward. At least there was an article in the Wall Street Journal this morning saying that the Fed would raise and then debate the pause. And I think it goes back to how much concern there is over the First Republic's failure and whether or not they want to pause and see what's going on. But I think on the flip side of that, we see inflation falling. In McDonald's quarter, for instance, they talked about inflation still being high single digits this year. That's very high. That's not 2% inflation that the Fed is trying to target. So even at 5% in interest rates, which they would be at the end of this meeting, it's still not that restrictive of a monetary policy stance. The rate of change has been high, but if you really wanted to get restrictive on the economy, probably going six or seven or 8% historically is where you have to get to in an environment like this. And so we're just tighter than neutral now, maybe. And so how that actually ends up impacting inflation and whether that's able to bring inflation down to the Fed's ultimate 2% target. We may not know the answer to that until midway or three-quarters of the way through this year.
Price-Driven Growth
"We delivered 12% organic revenue growth in the quarter. This was primarily driven by pricing actions across markets and revenue growth management initiatives to retain and add consumers. We also delivered volume growth of 3%, which is in line with last year versus 2019." - Coca-Cola (KO 0.23%↑) CEO James Quincey
"We delivered underlying sales growth of 10.5% in the first quarter, driven by price at 10.7% with underlying volume, down slightly at minus 0.2%" - Unilever (UL -0.20%↓) CEO Alan Jope
[00:06:55] Mokaya: So more tightening this week. And again, CPG companies don't give us a bit of hope. I compiled a little bit of data for our Twitter followers and it shows that most CPG companies are raising prices around double digits, low double digits, around 10% there. So it doesn't look like inflation is actually waning and this pricing is what is driving the growth of some CPG companies. They're reporting 12, 15% growth and these are not companies you expect to be growing at that kind of rate at this point in time. And the cost inflation should be a bit behind them now. I think they're just raising prices for the fun of it or to keep growing. That's my key takeaway from that. Any thoughts on that?
[00:07:37] Scott: Yeah, the thought in my head was, as a consumer right now, it feels like prices are painful, but not a deterrent yet.
[00:07:46] Mokaya: So if we were to take you as a good sample, then CPG companies have more headroom to keep growing a bit of pricing.
[00:07:54] Scott: Yeah, I think that's what they're seeing right now. That's the elasticity stuff. The CPG companies are saying like, we're raising prices, but consumers aren't spending a whole lot less. Their volumes are flat, their top lines are going up, high single digits, double digits even. But the consumer, there's certainly signs of deterioration that we've been seeing for six, nine months plus. But it's just not slowing down the economy fully yet. And that's why this is the best forecast recession in history and won't be surprising if we get it a recession. But securities prices don't reflect even 5% interest rates. That's absurd. Treasury yield is still at 3. Nobody thinks that we're staying at higher interest rates for longer.
Takeaways from Tech Earnings
[00:08:38] Mokaya: Yeah, definitely. Maybe let's talk a bit about the tech takeaways. Cloud spending is moderating. Google Cloud is profitable. They did a bit of accounting maneuvers and it's now profitable.
AI investments are accelerating across the board. All the tech companies that are reported so far, they're reporting an increase in investments. They may be decreasing investment in other areas, but at least for AI, they're increasing it. And finally Bing in Microsoft search wars continuing. Microsoft wants to keep growing its share of the market. They're very focused on share and gaining market share. And of course, Google is very keen on consolidating and making sure that they're now, Google is now the incumbent and then Microsoft is now the challenger suddenly in the market. So those are my three top-of-the-head takeaways from earnings calls. Let's start with cloud spend. Any takeaways from that?
"And in terms of CapEx, we do now expect that total CapEx for the year 2023 will be modestly higher than in 2022…And as we discussed last quarter, AI is a key component. It underlies everything that we do." - Alphabet (GOOG -0.23%↓) CFO Ruth Porat
“We expect capital expenditures to have a material sequential increase on a dollar basis, driven by investments in Azure AI infrastructure. Reminder there can be normal quarterly spend variability in the timing of our cloud infrastructure build-out." - Microsoft (MSFT -0.29%↓) CFO Amy Hood
[00:09:29] Scott: Yeah, I think my biggest takeaway from the tech space this week was really got those economic trends, and that's what I ended up zeroing in on in the end. Tech companies are seeing the same sort of headwinds that the rest of the economy is on in terms of cloud spend and in terms of consumer electronics demand. So those are weak. And then to your point, everybody's talking about AI and their CapEx spend in that space. But at least right now, it feels like we're in some sort of psychological consolidation around AI where the big surprise has happened. We all think that something big is going to continue to happen, but there's not some catalyst right now that's changing our perception of AI.
[00:10:12] Mokaya: Is it this period then you see like maybe people are taking time maybe to digest what happened and then to take maybe a year or two to actually get some really good products that would actually shake up the market once again, because now people are over the shock of AI is here now. It's okay, what are we going to do with it at the end of the day? I think that's where we are at, and every company is doing that right now. And then the funniest bit for me in terms of takeaway was that CPG companies are growing revenues at around 10 to 15% driven by pricing. And then tech companies are growing at 2, 3%. And then Meta just came off like three-quarters of declining revenue growth and now they're suddenly growing a bit at around 2%. It feels like a flip in the economy where the CPG companies are the fastest-growing companies around. And then you're back to tech companies being there almost moderating in terms of growth and all. The new economy, so to speak. Is that a good place to close, or do you have any thoughts to add this week?
Conclusion
[00:11:15] Scott: No, I think that's a good place to close this week.
[00:11:16] Mokaya: All right. Thank you so much for joining us this week. We'll have a special Twitter Space this Wednesday to discuss the banking crisis with two experts. So join us there on our Twitter space. We’ll include a link in the podcast transcript. And see you next week. Keep subscribing and keep sharing our content here and on Twitter. Bye for this week.
Slow Deterioration Continues