Welcome to Episode 73 of The Transcript Podcast where we discuss the key themes and takeaways from the Q2 2022 earnings calls.
This special episode is a recording of the Twitter Spaces conversation we held on Wednesday, 31st August 2022 with our guests Sam Ro of Tker.co and Alex Morris of The Science of Hitting.
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Show Notes
00:00:00: Introduction
00:05:21: The Fed and Inflation
00:11:15: Trading Down of High-Income Consumers
00:15:44: Retailers and Their Excess Inventory
00:20:31: Takeaways from Tech Earnings
00:23:00: CAPEX Trends
00:29:56: The State of Streaming
00:34:58: EPS Trends
00:40:48: Closing Thoughts
Episode Transcript
Introduction
[00:00:00] Mokaya: Thank you for joining us on the Transcript Podcast. This is a quarterly spaces where we get to talk about the key things that we learned from earnings calls. We do enjoy diving deep into earnings. We spend a lot of time within earnings transcripts. We read them, we attend them, and we review them weekly. Then we take key quotes from that, and that's what we put into our weekly newsletter. And then we have conversations around those topics that we've seen every week or so on our podcast. We are delighted to have Sam Ro, and Alex is going to join us a bit later. We'll just dive right in. Sam, you can introduce yourself to those who have not heard you before, and then you can give us a little bit of flavor on what you've seen in the last three months since we last had the spaces. Sam, welcome.
[00:00:44] Sam: Thanks. I'm Sam Ro I write the TKer newsletter, that's tker.co. And I write a lot about big-picture macro themes that affect the financial markets on the economy in the long run. I thought it was a pretty interesting quarter, just a couple of high-level things. Something that continues to surprise everybody is the degree to which companies can preserve pretty high-profit margins. It was another quarter where companies were able to pass on cost inflation through higher pricing. And everyone from consumers to businesses seemed to be continuing to accept this. There were some changes and I think behavior on the consumer side, which we're probably going to visit a little bit later, but yeah, it continues to be very impressive stuff.
I think about three-quarters of companies ended up beating earnings expectations and that always seems to be the case, but earnings continue to hold up pretty well. I think there have been some downward revisions by analysts for 2022 and 2023 earnings. But I think in aggregate, we're still looking at high single-digit growth for earnings at least in the S&P 500 for the next two years. I think the overall message is lots of concerns, heightened uncertainty, a lot of people talking about recession risk, and all this stuff. And I think we're going to get into that a little bit more, but despite all these concerns the corporate performance continues to be pretty resilient.
[00:02:07] Mokaya: All right. Scott, we've been discussing something very important that happened last week at the Jackson Hole Conference, and we did learn a lot from it. We did note a significant change in tone. You can start from that and give us a little bit of context and flavor on how the earnings have been over the last three months.
[00:02:24] Scott: I think going back to the beginning of earning season, the thing that has impacted me most this quarter, I think it impacted everybody was this pretty large rally in equity markets. And I think there was the perception that the Fed had taken a more dovish tilt. But also I think the bigger thing, honestly, was the earnings call commentary that was going on at about the same time where I think people were prepared for a negative earning season. And to echo Sam's point the commentary on the calls, I think if I had to sum it up was from CEOs saying, if there's a recession, we don't see it right now.
And so I think the optimism that made its way throughout the earning cycle helped to boost equity markets that had been prepared for the worst. And then I think now that we're seeing earning season trail off and you're seeing last week, you had the Fed at Jackson Hole come and reiterate a pretty hawkish stance. And honestly, Neel Kashkari yesterday had some comments that were even more hawkish to me than anything that Jerome Powell had said. So I think we're transitioning out of a period where there was a rally and now into potentially some more recessionary uncertainty, especially because as Sam alluded to where we did see softening was in the consumer space, I think.
[00:03:40] Mokaya: All right. Alex, welcome. Maybe can you introduce yourself and then give us a few general thoughts before we dive into the specifics.
[00:03:47] Alex: Yeah, sure. Thanks for having me again. I always have fun doing this. For people who don't know, my name's Alex Morris. I run TSOH Investment Research Service. The simplest way to put it is, I was an equities analyst for about a decade, and I left to start my research service where I effectively take everything I used to do at my job and I now deliver it to people through that substack. So it's deep dives on new companies, updates on the companies that I own and follow, complete portfolio transparency, and then some investment philosophy discussions. That's what I do day-to-day.
As I think about this past quarter, I just think it was messy and ongoing messiness from a number of things. FX is having a lot of impacts currently. Input costs are having a large impact currently for a number of businesses, and then honestly, the COVID kind of roller coaster for many of the businesses that I follow. It's been hard to predict or even to get your arms around how, at least, for me, the trends in some of these businesses have gone, and then trying to get some clarity on what the kind of normalized baseline looks like and thinking about what the growth rate looks like going forward.
There are a number of names that I think that this applies to. Match Group is an interesting one. I think the cable companies in the US are another interesting one, and then in certain businesses you've seen real pressure whether or not it's more permanent or transitory is to be seen, whether it's Roku, Snap, Meta, what's going on in retail, et cetera. So yeah, just a lot of messiness and the markets’ kind of concern coming into the quarter for some industries looks maybe a little bit too pessimistic in hindsight, and in other places, the forward-looking results are a little bit scary.
The Fed and Inflation
[00:05:21] Mokaya: That gives us a little bit of a context for the rest of the spaces. The first question I would want to put out to all of you about is inflation. In the past three months, we've seen inflation get almost close to 10% which has not been usual in the past couple of decades. What is your perception of where we are in terms of inflation and the economic situation generally? From the companies that you follow what are they saying about inflation? Has it peaked? Are we past or is the inflation still ahead of us? We can start with Scott since you spend a lot of time with me on the podcast, I know your thoughts, so perhaps you can share them.
[00:05:53] Scott: Yeah. I think from the things that we are reading in the earnings calls, and the commentary, it's clear that companies are feeling the inflationary forces starting to subside. So you have commodity price inflation that's been falling. Commodity prices have been falling back from their peaks. And then you also have the supply chain starting to normalize from the COVID era. I think it's still not fully healed. This kind of goes back to Alex's point, the COVID ripples are still making their way throughout the economy. And one of those places is still in the supply chain, but it's much better than it was 12 or 18 months ago.
And so those two inflationary forces are starting to subside. Now, I think you have to juxtapose that though or cross that with the inflationary psychology, which I think is like the larger undercurrent to inflation over the longer term. And I think we've shifted from the deflationary psychology that was pervasive from 2008 to 2020 into more inflationary psychology. And so whether or not we've attacked that I think is the question going forward. And that's probably what the Fed is looking at, even though indicators of forward inflation expectations maybe not be that high, we're still talking about inflation. The psychology is there, I think.
[00:07:10] Mokaya: Yeah. From Jackson Hole, I re-read the speech and listened to it today, I think the key takeaway from my perspective was that the Fed is concerned about the inflation expectations settling in where people expect for inflation. And then they get that into their business thinking, how businesses are planning, so they incorporate that. So I think that's their main worry that inflation expectations get anchored into business planning and forecasting. So I think that's why the intention is to bring down that inflation at the end of the day. So Sam and Alex, the companies that you're following and also maybe from the general outlook, are there concerns about how inflation is affecting the consumer or affecting how companies are planning and how are companies responding to this? Is there a squeeze in margins happening in some of the companies that you're following? We can start with Sam, then Alex.
[00:07:58] Sam: Yeah. First off, I think just hitting off on what Scott was saying and the shift into what may be inflationary psychology, I think that's an important sort of issue that we need to be paying careful attention to. The Fed's paying attention to this too. And related to this matter of, we're past peak inflation, I think we very well could be past peak inflation, but I think the more important question is how do we get back to 2% core inflation or how long does it take to get there? I think that ends up becoming the more important question because from peak inflation to 2% core, there are a lot of percentage points between getting from one end to the other.
I think that is where we have this sort of elevated degree of uncertainty. And it's not just about having high inflation anchored into both consumer and business expectations, but it's the sort of uncertainty that, are we going to have high-level inflation or are we going to get back to a low level? And, as long as we don't have any sort of confidence as to what inflation looks like down the road, 2, 3, 4 years from now or whatever it's incredibly difficult for anybody to do any planning. It's incredibly difficult for businesses to plan budgets and it's incredibly difficult for consumers to plan how they plan to spend in the near term, assuming they do any of that kind of thing. But yeah, getting back to the companies, I think sort of Alex's characterization of how everything was a mess is a good way to think of this.
It's funny, sort of at the high level you have these sorts of standard expected or stats that seem to repeat every earning season even pre-pandemic, right? You have most companies beating expectations, whatever that means, and generally speaking, earnings are growing. But yeah, when you get to the company level, it's just a gigantic mess. And even when you get to specific companies, I'll tell you that their own businesses are messes. I think Walmart was a very prominent name this quarter talking about how there were certain areas of strength. And there were certain areas where they just ordered too much shit and they have too much inventory and it's crushing their margins, and having to store all this extra inventory comes with all sorts of costs and stuff too.
As far as customer behavior and consumer behavior, Walmart was another great story. I think one of the things that surprised a lot of folks when they reported their numbers two weeks ago was they were talking about how a large share of their growth in their grocery business came from high-income households who are trading down from wherever they were getting groceries to somewhere that's a little bit more affordable like Walmart. So you're seeing a lot of those kinds of stories emerge with a lot of these consumer-facing names.
I think another good company when it came to commentary was a company called Fiserv, which I believe is involved in payment processing, they were talking about how they've noticed that there has been this big shift from high-end dining to fast food. People are still going out, but they're just spending a whole lot less. And I think McDonald's also said something similar where people were continuing to come into the McDonald's restaurants, but they're increasingly spending on the value menu as opposed to the higher price alternatives. Beneath the surface, at an aggregate level seems to be some pretty resilient spending. There are all sorts of shifts in behavior going on at the micro level. And yeah think it just creates a big nightmare for all these companies who have to figure out what consumers are doing, and at the same time try to plan budgets based on the extremely uncertain inflation environment.
Trading Down of the High-Income Consumer
[00:11:15] Mokaya: Yes. Before Alex jumps in, there's something that you raised about the high-income consumer trading down. It's something that we noted last week or so in Dollar General. I can read the quote, "We believe that we are able to capitalize on that trade down that we already seeing, and that trading down is coming from income levels that are upwards around $100,000." Scott, you had some good thoughts on this in this week's podcast. Perhaps you can share them, especially how you're seeing the high-income consumer trading down.
[00:11:42] Scott: Yeah. I think that to Sam's point, throughout the quarter, we picked up some cross currents in terms of whether there was trading down happening or not. It seemed like for a good early portion of the quarter some companies were saying that they are seeing signs of trade down, and other companies were saying that they weren't seeing signs of trade down. And I think where we ended up breaking it out was there's some softness in the lower income brackets, but not as much softness in the higher income brackets. And then also the thing that we noticed was that among consumer discretionary, there has been this big shift from goods back to services.
And so services weren't seeing any trade down, but goods were seeing like these inventory problems and things like that, just other headwinds in their business. But in the last couple of weeks, we noticed both Walmart and Dollar General talking about consumers that are making in the $100,000 income bracket starting to see a trade down in their stores. Shopping at Dollar General and Walmart is an indicator that softness in the economy may be starting to hit higher income brackets, but also is an indicator that maybe income brackets are shifting where a $100,000 doesn't feel so wealthy anymore.
[00:12:47] Mokaya: Yeah, I think that's what you're talking about like inflation making you, who was in the middle-income bracket suddenly fall back into the low-income bracket, just because of the impact it's having on the pocket. Alex, you can share with us the thoughts that you've seen, especially for some of the retailers that you follow. Any trends that you're seeing in terms of the consumer?
[00:13:06] Alex: Yeah. I think Sam and Scott did a great job of kind of capturing at least what I've been hearing. I think on Walmart's call this quote is a good example of at least what they've experienced as of late, "When we provided guidance three months ago, we didn't expect food and fuel inflation to accelerate to the levels that we experienced in Q2. In fact, Walmart's US food inflation was up double digits year-over-year, and we saw nearly 400 basis points step up as the quarter progressed compared to the end of Q1.” You're seeing very significant cost inflation for core and consumable products that people buying these products is not a choice, it's a necessity.
And then you're hearing both of them, Walmart and DG say similar things about the trade down, but also as it relates to Dollar General, more of a needs-based trip, and then people finding ways to shift the dollars that they spend to that core bucket by cutting back on a lot of these more discretionary purchases. And as I think about it was just a double whammy for those categories, given a lot of the stimulus and other measures that we saw as a result of the pandemic and also the type of purchases that those dollars went to because people were stuck at home.
And now in the back end, you've seen a lot of excess inventories and a lot of discounting to get those products out of warehouses or off the shelves. And I just think it's been a difficult environment for retailers that are geared towards less of a, call it core food and beverage or consumables purchase. And Target is the most prominent example there. Walmart's calling for high single-digit EPS declines this year. If I have my numbers correct, Target's EBIT margin guide is cut in half from what they delivered last year. I believe that's right at this point. DG on the other hand is still looking for something on the order of low double-digit growth, which just speaks to the nature of who these retailers are, who they serve, and also the value that they can add in difficult times.
One other interesting example I thought from this quarter, which is outside of retail was Microsoft talking about Azure. And people were very concerned heading into the quarter that if we started seeing a slow down in kind of the cloud growth that it would be a negative sign for the economy. And I thought Satya Nadella's comment about customers using the cloud as a way to improve their financial position. And talking about this idea of the public cloud would be an even bigger winner coming out of this because it does act as that deflationary force.
And as I think about all these names and the companies that I follow and aspire to own, this idea of relative competitive advantages and strengthening your position throughout market cycles, and I think you see it with at least those three names, in my opinion, Walmart, DG, and Microsoft. I think, they exhibit that ability, and it's part of the reason why I think those businesses just continue to get stronger and stronger over time.
Retailers and Their Excess Inventory
[00:15:44] Mokaya: Curious question about retail and how that's playing out. It's common knowledge now that most retailers are stuck with a lot of excess inventory going into Q3 and Q4. But are there any maybe second-order effects that will be coming from this that we should be watching out for? We are in a very highly promotional environment and of course, some of the retail I’m talking about have squeezed margins and all but going forward, what are you guys watching in terms of the various retailers and how they're dealing with the excess inventory that they have?
[00:16:11] Alex: I'll add a quick one before everybody else jumps in. I think the athletic apparel space is an interesting one because we've been going through this multi-year transition from wholesale becoming a less important part of the business over time, and direct-to-consumer coming front and center. It's an industry where there's a very long lead time on inventory. And you go listen to someone like Under Armour talk about how they think this industry looks over the next three to six months, and they just expect a ton of promotional activity as companies look to clear out what they've already ordered and what in some cases they couldn't cancel given where it's probably at in the supply chain. So I think retailers are one notable example. And again they've been hit by a double whammy of what happened in the preceding call it 18 to 24 months. But yeah, it's probably a good time to be a consumer if you have a little money to spend in some of these categories.
[00:16:58] Sam: Yeah. I think Alex just stole the words right out of my mouth. I think it's gonna be an amazing time to be a consumer. It's probably going to be a pretty great time to be doing holiday shopping, back to school, all black Friday sales, and all this stuff. It seems to be the case, like if everything that the retailers have been saying about excess inventories and overstocking and all of this stuff is true, then yeah, it should be a lot of items in the sales sections and the clearance sections. And while this might be a nightmare for retailer margins and stuff, at least, the investors know this is coming.
That's maybe one positive that might already be priced into a lot of these stocks too. As Alex said, this is going to be a positive for consumers who are going to finally see prices come down. And so hopefully we will begin to see some of this stuff show up in the CPI data in a more prominent kind of way. And if it does show up in the CPI and PCE’s next data, then we all know that J Powell and all of his colleagues at the Fed are following all these reports. That could be an even greater win if it turns out to be the case that prices for some of these goods begin to put a dent in these inflation baskets. And then maybe, sometime soon we hear about an actual Fed pivot, as opposed to, this sort of confused not so much of a pivot.
[00:18:17] Mokaya: Scott, any thoughts on that?
[00:18:18] Scott: I think in terms of the consumer, one thing that I would point out just add to this conversation that we picked up last week was a comment from an American Airlines Executive talking about travel going from maybe normalizing in the fourth quarter of this year instead of the white-hot period that it's been in. I think that was an important indicator to me about the state of the consumer today as well because the consumer has been so important to the rebound in travel. There's been not a lot of business travel, but there's been a lot of leisure travel and people have been binging on it for the last 12 months or more, especially during the summers of the last couple of years.
And so if that is starting to turn in a different direction at all that's an indicator that's somewhat negative to me for the consumer as well. I think an anecdotal note on that is I was looking at tickets to go from Los Angeles to Seattle, which is a route that I travel frequently they used to be like $300 before the pandemic, yesterday I tried to buy a ticket and it was $1,200 for the ticket. So there is pretty insane inflation in ticket prices for airplane tickets.
[00:19:28] Sam: If I can just add something real quick to that, again, I get this gets back to what Alex was saying about how everything's just a mess right now, right? As much as, so many people are being impacted by inflation on non-discretionary items like food and gas at the same time the airlines and the hotels, and Disney World are all benefiting from all this discretionary travel. Now, maybe there's a case to be made, that maybe taking time off is not a discretionary item, but it is interesting to see the degree to which so many of these businesses that are involved in the vacation business flourish.
And I don't know if anyone's looked into planning a trip to Disney World recently, but it's just completely out of control how expensive it is to go there. Not to mention all of the sorts of add-ons that come with going to Disney World that you have to wait in line for. But yeah, maybe it turns into the case that this winter airline travel and some of this stuff does normalize a bit. And then, there is a rotation back from the shift to services back to a shift to good spending.
Takeaways from Tech Earnings
[00:20:31] Mokaya: All right. One more thing about the main impact of inflation is of course, in this quarter, we also noted from the earnings call that a few of the commodities which spiked in price in the first half of the year are slowing down going into the second half of the year. So perhaps that could impact inflation going forward, any thoughts on that? And also you can touch on tech earnings, Alex, and what you observed there this quarter that can be of relevance to the listeners.
[00:20:56] Alex: Yeah, in terms of tech earnings, at least, the high-level numbers that I saw for some of the bigger players, and Microsoft is the one that I follow most closely, it was still a fairly strong quarter. The forward guidance was still very strong but it seems again, as I was saying earlier for a company that's serving kind of a core business need and a solution to some of the problems we're discussing here, it seems like they're still figuring out what they need to do to keep growing and keep improving the business. The tech space that is monetized through primarily online advertising that's become a very messy story for a number of reasons; IDFA, and the economy.
And for some of these companies, there are questions about user growth and engagement as a result of new competitors like TikTok. It's messy and we've all probably seen what's been going on with Snap where it's safe to say they have not navigated this period as well as they probably would've liked to in hindsight. And on the other end of the spectrum, as you're looking at a big company like Meta you're seeing them now deal with the difficulties coming out of last year, recognizing that they need to provide more clarity about the FRL investment spend.
And they came out and did that in a way that I think was pretty reassuring to the market in terms of what that would look like, the framework. And then they immediately got sideswiped by the slowdown in the advertising market, which is not the sole consideration, but if you compare it against some of what I think are reasonable peers, you can see it's largely impacted by that. So it'll be interesting to see. This goes for many companies, especially, when you introduce a lot of stock-based comps and you have to think about the cost of capital more than you might in some other situations.
It'd be interesting to see how they navigate this period. Even if we're only talking about a temporary slowdown that lasts six or 12 months, that's a long amount of time when you're living through it. I think we have seen…, and again, you can throw Roku in this bucket. You can throw Match in here for a different reason, but it'd be interesting to see these companies now that they've pulled back on some of the guidance and some of their thinking in how they make the adjustments in terms of moving forward.
CAPEX Trends
[00:23:00] Mokaya: Speaking of the adjustments they need to make, I think Sam noted something about companies still keeping up their CapEx levels high, despite the kind of slow down that you've seen in some of the pockets of the market. Sam, any takeaways from that?
[00:23:14] Sam: Yeah, I think there's a couple of things. And this gets a little bit more sort of industry-specific as to which industries are thriving, and can continue operating without having to make some big announcement about layoffs and restructuring versus the ones that are being affected by this. I think Alex is probably going to have a better sense of this than I, but this seems to be the theme especially when it comes to high-growth companies, and zero to no cash flow companies the demands of the investors are shifting from an emphasis on top-line growth and more toward generating some positive cash flow which explains a lot of things like layoffs that we're hearing about in the tech industry. But getting back to this sort of super high-level economy-wide trend that I've been seeing there are two things. One, capital expenditures, the spending in that area continues to be pretty strong. Some of it's going to be inflated by inflation, of course, but there hasn't been any kind of major drop-off in CapEx that you might expect in a slowing economy or what executives might expect to be a slowing economy. That gets back to what we were talking about earlier, about how there might be a lot of concerns about a recession or a big economic slowdown, but at the company level I haven't seen a whole lot of companies talking about cutting back on spending, cutting CapEx, cutting back on their growth initiatives, maybe trimming in areas that might have been a little bit too aggressive, but generally speaking, it seems like companies are still positioned for growth. And it's reflected in what continues to be growing core CapEx orders numbers, which is for stuff that hasn't even shipped yet.
And then the other side of it is there continues to be a whole lot of job openings out there. Now, I think there are a lot of questions about how clean job openings numbers are. But I think, generally speaking, we can agree that there are probably still concerning more job openings out there than there are folks seeking work, and all that stuff is confirmed by the fact that I think just last month the US added 500,000 payrolls, and year-to-date has added 3 million jobs. Now this is during a period where economic data is slowing, GDP goes negative, but companies are hiring. And this is not just S&P 500 companies, these are the BLS numbers that are accounting for all businesses in the US, for instance. So companies are hiring, the unemployment rate number is at a 50-year low and the rate of layoffs is still below pre-pandemic lows. There's a lot of data out there that's saying that companies maybe they're not positioned for red hot growth, but they are not making moves that are indicative of an economic decline. And I end that by saying so far, this is something that you keep an eye on to see if the numbers start to move. If layoff activity starts to pick up then yeah, maybe it's more reflective of what may be a recession down the road, but for now, companies continue to spend on CapEx and they're continuing to hire, and layoffs continue to be very low.
[00:26:13] Alex: I’m just going to add something real quick. I think one of them hits on one of the things that Sam said there. And we’ve talked about Airbnb a lot in the past is a company that...it's funny. They were hurt very significantly early in the crisis, but I think it's a situation where, because of who they were coming into the crisis and what it forced them to do, they've emerged in a much better place. There's something that Brian Chesky, the CEO said in an interview once that stood out to me. He said, "One of the lessons I learned in the crisis is you can't do everything at once. I had an idea that started in my living room within years, hundreds of millions of people used it, and we had access to billions of dollars of capital. And you can convince yourself, I can now do that 10 more times. How many entrepreneurs try to do 10 things at once? It doesn't work. One of the lessons I learned was to focus net ruthless prioritization."
And I think you see this is not just young or small companies, and this isn't black or white either. Again, you see it at Roku as they've certainly changed their wording and their perspective in terms of how they're going to think about investing in content. You've seen it at Warner Brothers Discovery, where 15 months ago the goal was 200, 300, 400 million paid subs, and very confident comments about how they will be a leader in video-on-demand competing with Netflix and Disney. Now it's more of a, is that even the right goal for us? And it just leads to a lot of rethinking and finding what you need to ruthlessly prioritize when you go through difficult periods like this.
And that can present an opportunity in the case of someone like Airbnb too in my mind, to get better and be more thoughtful about the timing for you to pursue secondary initiatives like experiences which could be a big part of the business for them over time. It also introduces the risk that you shift your goals and don't invest in things that might be important for the future. So it's always hard to say in real-time, but you're seeing companies that are just changing some of the areas that they're focusing on as it relates to the long term.
[00:28:04] Mokaya: I think one company that is not changing much in terms of the areas of focus is Meta and Scott is a big fan of it. Scott, how is the metaverse doing?
[00:28:11] Scott: Okay. It's so funny that you always characterize me as a big fan of Meta. I think that Mark Zuckerberg's one of the best CEOs in the country, and I think that he's not somebody to underestimate, but when you look at Meta, there are no catalysts right now to turn around the trajectory of the company. Not anything that's immediately emerging. I think it's a cheap stock, but there's not a whole lot more going for it right now. And so it's one to watch because it's so cheap and it has excellent management, but it's going through a choppy period.
I think one thing I wanted to comment on, though, that seems to have been the theme of this Twitter Space is just mixed messages and the sloppiness that we're seeing throughout the economy right now. And I think the labor markets are one area where it's like a cross current relative to other things that we're seeing. And we talked about this a couple of weeks ago on the podcast that we were seeing this in a lot of different places and that we were thinking, we'd probably get some clarity as to which direction the economy's going over the next few weeks. And I think Jackson Hole was a big thing for, at the highest level, on the Fed level of we have this like stub piece of a comment that we may have to slow the pace of rate increases that kind of underpinned a big rally in the markets.
And then Jackson Hole gave us the clarity of, oh no, they're seriously hawkish. And I think there are a lot of other places. Semiconductors is another one where I think that there are cross currents going on where you're reading many semiconductor companies talk about weakening consumer demand and over inventories. But then you're also reading like auto companies still talking about difficulties and procuring semiconductors from their supply chains. So this is just another area where it's which way is it headed? We're in this digestion period and we'll probably find out in the next few weeks.
The State of Streaming
[00:29:56] Mokaya: Yes. Maybe we could open up to the audience a little bit. If you have some questions, we have 20 more minutes, so you can just DM us or could just request to speak. So if you want to join and be part of the conversation, what we're discussing are just the key takeaways from the Q2 earnings calls. If you missed a large part of the spaces today, we'll make it into a podcast and release it sometime next week together with the links and some of the quotes that have been shared here today.
Now, in the last 20 minutes, I want to take a pause and reflect a bit on some of the things that you guys are watching going into Q3. One of the things that we are watching very carefully is companies like Netflix, which for a long time following the earnings calls have been very reluctant to do ads and now suddenly they're having to switch to put up ads in some of their tiers. Alex, you can talk a little bit about how the CTV market is doing, and Scott, you can add on that, especially the streaming market. That's something we watching very closely at the Transcript this year.
[00:30:51] Alex: Yeah. One of the things I'm watching is M&A, especially as Meta is having a lot of challenges with getting these incredibly small and inconsequential deals across the finish line on M&A. One thing I'm watching closely is, for example, Microsoft ATVI, and whether or not that's a deal that can get done or not. The commentary around it continues to be pretty constructive from the things I've heard from management, but we'll see whether or not that can happen. And I think that deal getting done, potentially signals things for at least a lot of the companies that I follow. Some names that I throw in there that potentially could be relevant are Roblox, Spotify, and the media space. Places where M&A even if it's not particularly likely, certainly can be a relevant consideration, especially as businesses deal with changes in their trends and movements in their stock prices. But we'll see whether or not there's a capability for big tech to step in and do like in the case of Facebook small deals, but for some of the other players, deals that are measured in the tens of billions of dollars. So we'll have to wait and see. In terms of the ad market and connect TV and video-on-demand, I think you see pretty clear trends in terms of at least the US streaming taking a significant amount of market share from linear. And that's partly informed by the value proposition for pay TV where ratings are moving in one direction and the cost are moving in another direction.
Companies are increasingly putting their best content on streaming first, or at least not on a linear channel. And despite a lot of commentary about R2s moving higher, you're in the short term still seeing a lot of promotional activity to try to lock people into annual plans, or whatever it may be. So there are a lot of moving pieces there. And I honestly think another consideration is if we go back a few years and think about the MVPDs coming in at price points that were, in some cases, $30, $40 a month, which is quite a bit cheaper than what you would pay through a traditional pay-TV provider.
Those prices moved higher over time, which in my mind was partly an indication that the dream of this being a much more effective advertising vehicle was likely not supported by the actual results of the businesses. Now we're a few years past there, and I assume there have been incremental learnings and potentially some ability to improve what is shown and drive higher CPMs. It may have changed what R&R looks like on an ad-supported service relative to simply a SPOD service. I dont have real impacts in terms of some of the competitive dynamics and how these services are priced. So there are a lot of moving parts, and again I come back to this frequently, as I think about companies that I'm looking to invest in. Its relative competitive advantages in terms of strategic focus, financial flexibility, quality of the asset base etcetera. So we will see how it goes from here.
[00:33:37] Mokaya: Scott, on the state of streaming.
[00:33:39] Scott: Yeah. This is an interesting one because I think the first half of the year, or the first quarter after Netflix is a big blow-up quarter. I think that you and I were capturing a lot of potential interest in advertising video-on-demand. And I thought at the time that it would be probably a pretty successful thing. As Netflix is turning its battleship to be advertising based in addition to free, I've started to think that this is a colossal mistake. I don't know that this is going to be a very very strong business model, mostly because I took the experience of joining some of these streaming services on demand, like a Hulu subscription with advertising.
And I think we've all been trained to watch things without commercials now, to the extent that it's a pretty poor user experience to be watching advertisements in the middle of your show. So I think that's an interesting thing to watch on Netflix. And I'll say, conversely where I think that there will be strong growth is in the rental and the micro-transaction basis. So if I'm not a subscriber to Hulu, but I want to be able to watch a Hulu show, for a single show without a subscription, I would pay five, $10, whatever it is to rent the show and be able to watch it. So I think that probably ends up being the growth area, even though Netflix is just putting a ton of time and investment into its advertising-supported business.
EPS Trends
[00:34:58] Mokaya: Yeah. We are joined here by Paul Cello. Just maybe a quick comment from you, Paul.
[00:35:02] Paul: Hey guys, I'm sorry. I came in late, so I'm not sure if you guys have spoken about what you see going forward in the back half of the year as it pertains to EPS. Just kinda curious about your thoughts there.
[00:35:12] Sam: I can jump in. I think one of the craziest stories of at least the first half of the year was not only that EPS for 2022 and 2023 were not coming down, but they were going up. They spent most of the year going up, and I think in just the last couple of months they finally started to come down. Now I think in aggregate the analyst…so it's like when you aggregate the bottom-up estimates they're still looking for high single-digit growth for 2022 and 2023. But of course, all that is going to be contingent on what happens with Q3 and Q4 earnings which is always uncertain, but it feels a lot more uncertain this time around than historically.
Historical patterns always included a period where analysts cut quarterly earnings estimates going into earning season, and then 50, 60, and 70% of these companies end up beating those expectations. Beating estimates is a phrase that doesn't have much meaning but getting back to the core issue and the core question it does come down to I guess sort of execution at the company level, like how they are planning for what might be a slow down in demand or potential declining demand, how they're planning for pricing. What do they have hedged in terms of their costs? What costs are already locked in? I hate using this kind of phrase, but I think this is very much like the stock pickers market, where if you have a good sense of how this company operates and how it's positioned for the current, or the near-term macroeconomic environment, then you'll be able to find which companies will be able to clear that hurdle of earnings expectations.
But yeah, it's strange because again, in addition to earnings expectations being pretty resilient for most of the year, a lot of that has been supported by what have been historically high-profit margins. And a lot of it's been driven by the fact that these companies have been able to pass higher costs off to their customers through higher pricing. For me, I think the thing to watch with Q3 earnings and potentially, pre-announcements going into Q3 earnings, is to what degree companies are continuing to have pricing power that they're continuing to be able to pass on the high costs to their customers.
Now, we just had 0% CPI in July, right? So maybe there's less pressure there, but if it is the case that economic activity is cooling, then just keeping prices level might not be enough. It might be the case, that the companies that can cut prices yet preserve margins are going to be able to hold up. I think it's just a whole mess of uncertainty. I think it is going to be the case where everyone's going to want to watch how companies are executing when it comes to pricing. Because that's going to filter down to margins, and ultimately gets down to what's literally the bottom line with earnings, right?
Just two quick things off the top of my head, just looking back at the last CPI report, for instance, we were just talking about how airlines are doing great and people are doing all this vacation travel, but Scott also mentioned that there was this quote from American Airlines recently about how they're expecting to go into a more normal travel spending period. If you were like a high-growth startup or whatever, and you said that you're going from white-hot growth to normal, your stock is going to crash. But it's an interesting thing because one of the interesting line items in the last CPI report that stood out was airline fares. And I have the report in front of me right now.
And during this month where you have 0% CPI growth, you had an 8% drop month-over-month in airline fares. So in some ways, maybe that's an area or maybe that's an indication of what's to come. Now to put into context, airline fares according to the CPI report are still up 28% from a year ago. God knows what you're supposed to make of that. But yeah you have to wonder at what point the consumer just refuses to take these higher prices. One thing to note though, when we're talking about stuff like real incomes and wage growth and all this stuff I think something that often gets lost in this conversation about wage increases and how that affects retail spending, consumer spending, and all this stuff is the population of people who are earning money is a number that's been growing. While you have a certain amount of wage growth that's amplified by the fact that 3 million jobs have been added this year, that's amplifying the spending power on the consumer side.
At the individual level, you might have flat consumer spending, but because there are more people employed who can spend you might get growth in those consumer spending numbers. That's four-dimensional thinking here. I think there are a couple of offsets there, but eventually, you do get concerned about when consumers will stop absorbing all these prices. Now, I think one thing that we didn't mention, but we've talked about I think in previous spaces is this whole matter of excess savings, right? All this extra money that consumers have accumulated since the beginning of the pandemic because of government aid, fiscal stimulus, and just a year's worth of not being able to spend money on anything.
I think the latest estimate is that's still over 2 trillion now which slants more toward folks on the higher income side. Even on the low-income side, there is still quite a bit of extra cash on a lot of consumer balance sheets. Yeah, I don't know at some point it does break, but the consumers have enough financial flexibility and the other thing to keep in mind is consumer balance sheets are just generally in a lot greater shape. They're carrying a lot less debt than… in aggregate yes, credit card balances and all this stuff are starting to increase, but relative to their aspects, it's still pretty low. So it looks like consumers have a lot of spending capacity, but at some point, it's a good question, at what point does sentiment catch up and people decide that this shit's just not worth it?
Closing Thoughts
[00:40:48] Mokaya: All right. Now we should be going to closing thoughts and maybe any other things that you may have missed out on, or at least not covered. I would start with Alex and then Scott on that.
[00:40:59] Alex: Yeah. First of all, thanks again for doing this. I always enjoy these and always learn a lot from the other speakers. And the questions are always great too. So thanks for having me. What I'm focusing on is probably what I've said in the closing remarks. Every time we have one of these, which is just thinking about the companies I own and thinking about how they stand on a relative basis with their competitive set and how can they strengthen their position in times that are both good and in times that are bad. And this year's been, or maybe even this past six months has been an interesting learning experience for me in terms of a lot of the messiness that we've talked about and seeing how that messiness works its way through an industry.
I think streaming video is a clear example where it's already shaken out in a lot of ways. It's become a lot clearer where companies are trying to go even from six months ago. I think the connectivity industries with cable and wireless are at an earlier phase of that, but it's definitely shifting. And as it relates specifically to the quarterly calls and companies communicating about their vision, it's where the rubber meets the road. And another prominent example is Meta, as I discussed, a very large business with very significant free cash generation, and Zuck's position in the company.
He operates as a controlling owner but even there you see how periods like this require a certain amount of outreach to the people that are invested in the companies, whether it's employees or just public shareholders, and you have to adjust and you make reasonable plans for moving forward. And that's not always clear in the thick of the fog, but there are always changes being made. And I find it fascinating to think about how some of the decisions made today will impact where these companies are five to 10 years from now. So it's always fun to watch. I don't always have the answers, but I greatly enjoy watching.
[00:42:42] Mokaya: So back to Scott, what are you watching on The Transcript in the next three months?
[00:42:46] Scott: I don't know if this is necessarily The Transcript, but I guess the one concept that's come up in this Twitter Space that I wanted to touch on a little bit was the state of labor markets. And the fact that labor markets are still strong. And I think that one of the like mantras of a macro analyst is that unemployment is a lagging indicator. And so in this instance, at this point in time, unemployment could be lagging or labor markets could be lagging and how strong they are. And they could be adapting to a consumer that seems to be weakening, capital markets that have already significantly weakened over the course of the year. Still, everything to me lines up with a fairly classic recessionary period here, especially with the fed doubling down on its hawkish stance.
And I think that the thing to go back to is that at Jackson Hole, Jerome Powell was talking about there being supply and demand imbalances. And he honed in on the supply and demand imbalances in the labor markets, especially. There's a supply and demand imbalance there. And so to the extent that he's watching labor markets and waiting for them to deteriorate, you're already well into a recession by the time that indicator starts to flash recessionary warnings. So if the Fed is going to react to that and wait for that to happen to become more dovish, I think that's one of the most bearish things that I'm watching. And so that I think is the indicator to keep an eye on as we're going forward over the next few weeks.
[00:44:16] Sam: Yeah, I'll just say one quick thing. And again, thanks for having me on, this is a lot of fun and informative to get all these different perspectives. One thing I think Alex touched on this pretty early on, and this is also related to the Fed and tighter monetary policy is the strength of the dollar. Rallying the dollar against a lot of overseas currencies has been impressive but that becomes a big headwind for a lot of big multinational companies. I think something like 30 to 40% of revenue generated by SME 500 companies is generated abroad.
And I think in Q2, companies did break out, exactly to what degree unfavorable currency movements cost them on the top and bottom line but for the most part, the earnings that get reported by the media or whatever, tend to be on this sort of constant currency basis. So I think that's something to keep an eye on. At what point, do these sorts of extreme currency movements begin to affect not just individual businesses but entire economies?
[00:45:17]Mokaya: All right. Thank you. Thank you all for joining us on the spaces today. Usually, it's Scott and me who write the transcripts. Sam has TKER, and you can check them out tker.co. And Alex Morris you can check him out at the Science of Hitting newsletters weekly and has insights into how various companies are doing. Thank you for joining us today, hope to see you again in another two or three months as we do the Q3 earnings review. You can always join us every week on thetranscriptsubstack.com where we have our newsletter. And we also have our podcast every week where we collect key thoughts from earnings calls, from various business leaders, and then try to see where the economy is going and invest based on those insights that we generate. Thank you for joining us once again. See you next time.
Q2 22 In Review