The Transcript Q3 2021 Letter

What we learned from Q321 earnings calls

Editor's note to our readers: Last quarter we began writing a quarterly letter to review the trends that we saw throughout the earnings season. This week we are publishing our letter for the 3rd quarter.

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Macro:

The global economy showed continued strength as it rebounded from the Covid era. In the 3rd quarter, even the hardest-hit industries began to return to 2019 levels. We saw retail store traffic, live entertainment, and ride-sharing all perform well as consumers engaged in out-of-home experiences.

"We have seen continued improvement in cross-border, and this is across both travel and nontravel. And we have now reached pre-pandemic levels relative to 2019 - Mastercard CFO Sachin Mehra

“But overall, credit card spend, I would say, is robust.. if we look at spend right now, even with that softening relative to 2019, we’re still up 18%, 19% relative to 2019, notwithstanding that those sort of key areas are down. And remember that ours is a portfolio that has a decent skew towards travel and entertainment." - JPMorgan Chase Co-CEO of Consumer & Community Banking Marianne Lake

We also saw continued supply chain challenges that don’t show any signs of healing. Demand is there but the constraining factor is supply with companies having challenges meeting demand. However, there was some shift in the focus of the difficulties. More emphasis seemed to be on port congestion.

"We are seeing that customers are considering alternative option to move cargoes as port congestion and containership capacity constraints continue” - Stolt-Nielsen CEO Niels Stolt-Nielsen

“Across our business right now, the supply chain is really our limiting factor. Demand is extraordinarily high for all of our products both on the consumer side...but also for our flavor solutions and flavor systems business...Transportation and logistics issues, just getting the product from point A to point B, is our single limiting factor. It’s not demand. Demand is incredible.” - McCormick CEO Lawrence Kurzius

Demand is really high, the only thing that indicates that -- the only thing holding it back are supply chain challenges, which we need to help solve for our customers." - Norfolk Southern CMO Alan Shaw

"In the fourth quarter, we expect to incur several billion dollars of additional costs in our Consumer business as we manage through labor supply shortages, increased wage costs, global supply chain issues, and increased freight and shipping costs" - Amazon

"I would tell you that we are seeing a significant increase in freight costs. And I would assume that that is pretty consistent across different companies. And so we’re clearly seeing some inflation there." - Apple CEO Tim Cook

Labor shortages were also acute around the economy with many companies complaining of not being able to get enough workers.

"…in terms of our labor shortage, I mean, the demographic deficit that we’re facing throughout North America is nothing new and it’s going to be around us for a certain period of time. So again, there’s going to be a period of adjustments, but I don’t see that problem going away in the next few months” - MTY Food Group CEO Eric Lefebvre

"In Q3, labor became our primary capacity constraint, not storage space or fulfillment capacity" - Amazon CFO Brian Olsavsky

"Our employee tenure is -- has shortened dramatically, and so it's changing how we staff because we have to staff more people to get the product out the door." - Kimberly-Clark CEO Mike Hsu

“...You can't go anywhere in America without seeing help wanted and we're hiring signs at every retail store, at every fast food place. Wherever you turn, people are looking for quantity workers -- quality workers. And among other things, that means you have to pay them.” - AMC Entertainment CEO Adam Aron

Inflation surged along with this demand and supply imbalance. CPI rose at 6.2% in October, which was its highest increase in 30 years.

"Obviously, we're in a more inflationary environment broadly. Thank you, Federal Reserve and the US Congress, for fiscal and monetary stimulus. We could debate transitory or otherwise.But those things are translating into broadly a more highly inflationary environment. And that applies to us too, and that obviously is helping from a pricing power point of view." - Hilton Worldwide (HLT) CEO Chris Nassetta

“The cost inflation we are seeing is pretty much global. It's mainly -- it's a global phenomenon” - Agfa-Gevaert CEO Pascal Juery

"In the last few months, inflation has continued to ratchet it up…We’re experiencing the highest inflationary period of the last decade or even two” - McCormick & Company CEO Lawrence Kurzius

The rising cost and labor pressures are putting pressure on margins. Some companies are doing better in handling supply chain issues by passing on price increases.

“In addition to the significant supply challenges, raw material pricing remains highly elevated, and we are increasing our full-year raw material inflation outlook to be up a high-teens percentage compared to last year. We continue to combat these elevated costs with pricing actions across all of our businesses,” - Sherwin-Williams CEO John G. Morikis

“When combined with cost increases we are seeing from many of our suppliers, these factors are putting pressure on our gross margins. While we thoughtfully raised prices to offset this impact, the benefits are not immediate and will be recognized over the coming quarters” - Charles H. Robbins Chairman & CEO, Cisco Systems

“Right now, our short-term view is that we should be able to offset cost with price and maintain our margins that are around the level that we just reported in the fourth quarter. But, truly as we move through fiscal 2022, it will depend on the strength of the demand environment.” - D.R. Horton CFO Bill Wheat

Despite this surge in inflation and tight labor market, the Federal Reserve maintained a generally dovish policy. They did begin to taper asset purchases, but seem not to be in any hurry to address inflation.

"...the focus at this meeting is on tapering asset purchases, not on raising rates. It is time to taper, we think, because the economy has achieved substantial further progress toward our goals measured from last December. We don’t think it’s time yet to raise interest rates." - US Federal Reserve Chair Jerome Powell

"The Fed has the tools to deal with inflation, but those tools generally don't feel good when they have to be applied -- if they have to raise rates quickly to offset it, that can have an impact on the economy, which traditionally is not pleasant. But the reality is that if they can stay ahead of it, it works -- But you'd rather have that challenge being thought through as loans are growing, deposits are growing, consumers are spending more, the economy is as big as it was. And so taking the accommodation out of the economy by slowing down purchases or raising rates is different in that kind of strong backdrop." - Bank of America CEO Brian Moynihan

International:

International economies also showed signs of a rebound after Covid. We read some quotes to suggest that Europe is making a stronger rebound than most people appreciate.

"So first on Europe, we could -- I think the recovery in Europe, by and large, is underestimated in the U.S. by most observers, both from an economic standpoint as well as in terms of activity levels. We're seeing a record level of activity, at least for our business across Europe right now, which is very encouraging." - Lazard CEO Kenneth Jacobs

"Europe has opened up faster than the US -- What we're seeing now in a lot of European markets is that demand is like higher than pre-pandemic." - Uber Technologies CEO Dara Khosrowshahi

Emerging markets also are benefiting from the global distribution of vaccines. More than 7.63 Billion doses of Covid vaccines have been administered worldwide. This is particularly good news for the supply chain since many bottlenecks have originated in Asian countries. In particular, lockdowns in Vietnam were cited as a source of pressure.

"There was a bright spot during the quarter with the foam supply as our vendors do not see this as an issue moving into the fourth quarter. Vietnam began a shutdown in late July and things accelerated in August, where a majority of our factories were closed for the months of August and September. We are getting positive news from our vendors as they began opening at the beginning of October" - Haverty Furniture President Steven Burdette

"I think what we're seeing is that the consumer confidence is improving in markets like India, big parts of Latin America, they are seeing the vaccine roll-out, they're seeing life going back to normal. They feel better about their personal finances and that is reflected in their consumption." - Mondelez International CEO Dirk Van De Put

China’s economy is a laggard though. In particular, its real estate sector showed signs of distress.

“I would say, what gets the headlines is that Chinese real estate has an issue. But really what it is, is it's the residential developers that built -- were building condos, had significant amounts of leverage in the companies, and that is unwinding itself given what's going on in the country. They say real estate, but really what the focus is on is the residential condominium developers in all the types of cities, tier 1, 2, 3, in China.” - Brookfield Asset Management CEO Bruce Flatt

Financials:

Banks reported strong quarters with low loan delinquencies and continued release of loan loss reserves.

"It was an exceptional third quarter this -- the firm delivered, and it's contributed to year-to-date revenues of 45 billion. To put this in context, year-to-date revenues surpassed full-year 2019 revenues by nearly 10% as of this stage. Our business model continues to generate durable revenues, high returns, and strong operating leverage, and we produced an ROTCE of over 20%, both in the quarter and on a year-to-date basis." - Morgan Stanley CEO James Gorman

The meme stock and retail trading frenzy from earlier in the year appears to have slowed down some.

"In Q3, we saw considerably fewer new funded accounts and lower revenue as compared to Q2 -- In Q3, crypto activity came off record highs leading to fewer new funded accounts and lower revenue as expected. Historically, our growth has come in waves. The surges have come during periods of increased volatility or market events." - Robinhood CEO Vlad Ten

But the most exciting segment of the financial industry continues to be the world of crypto-currency, NFTs, and Central Bank digital currencies.

"Our content security team has responded to the rise of non-fungible tokens, or NFTs, by rolling out a service focused on securing the marketplaces or games where these digital assets are bought and sold. This leverages our existing capabilities and brings an adjacent offering to the market" - TaskUs CEO Bryce Maddock

“…we are seeing really strong and accelerating pace of crypto adoption globally. In the letter, we actually shared some insights on the pace of this adoption and how it mirrors that of the Internet 25 to 30 years ago” - Coinbase CEO Brian Armstrong

“Digital currencies have experienced significant growth in recent years and the market value for cryptocurrencies reached $2 trillion this year. We are seeing heavy investment from banks and governments in their digital currency space and there is a big market for solutions that solve the problem of trust with these new currencies.” - Mastercard President Cyber and Intelligence Ajay Bhalla

Consumer:

Consumer spending continues to be very strong, and spending patterns are showing some post-Covid normalization. Consumers are also accepting of the increased prices.

"We haven't seen, I’ll say, any more resistance to our price increases than we've seen historically. So that the 6% has been pretty well received by customers." - McDonald's CFO Kevin Ozan

“We have already made 2 price increases. And so far, I can say these price increases have been accepted by our customers. We are now preparing for the third one, which will be even probably more significant than the other ones. I believe that there is overall an acceptance rate.” - Agfa-Gevaert CEO Pascal Juery

"Very early to read anything in terms of price elasticity. I will tell you for those price increases that have gone into the market in the U.S., most of them became effective middle of September and we have not seen any material reaction from consumers in terms of volume offtake" - Procter & Gamble CFO Andre Schulten

"Despite higher prices, we are still sustaining a higher double-digit percentage retail pace currently than 2 years ago." - Winnebago Industries CEO Michael Happe

As part of that normalization, some industries that had benefited from Covid saw headwinds. E-commerce growth, for instance, slowed in the quarter as more consumers went to the store, a clear demonstration that brick and mortar isn’t dead.

"As the world begins to reopen, shoppers are returning to stores. Brick and mortar aren’t dead. Instead, omni -channel is in full force. Searches for open now near me are four times globally versus last year." - Alphabet SVP & CBO Phillip Schindler

"Another external factor is slowing e-commerce growth. The strong e-commerce growth in recent quarters was driven in part by the acceleration of the digital transformation that is now tapering out…but e-commerce is no longer growing at the pace it was at the height of the pandemic." - Facebook COO Sheryl Sandberg

"As the world begins to return to some normalcy and the extreme levels of online shopping over the past year make way for more in-person retail and experiences, e-commerce's share of overall retail has reset lower than the peak last year, but still several points higher than it was two years ago and is poised to resume a more normalized rate of growth and continue its share gains of retail over the long term." - Shopify CFO Amy Shapero

"...merchants need to be where their buyers are. This past quarter, more buyers were in stores as brick-and-mortar reclaimed some of its share of retail." - Shopify President Harley Finkelstein

Companies are building upon inventory to meet the expected surge in demand over the holiday season. There is also a real worry of what would happen if the supply chain situation lifts and many are left with excess inventory.

"…is this something that's part of our new normal that we're going to have this kind of consternation and we need to build an extra 30 or 45 days of time into the supply chain? The risk is when that flips. And again, I don't know if it's 6 months from now or 6 years from now. When that flips, we have to be acutely aware it's happening when it's happening because right now we sell $13 million worth of inventory a day. If all of the sudden stuff comes in three weeks faster, four weeks faster, you get -- well, 13 times 20 business days in a month, that's $260 million. So you could add 100, 200, $250 million of inventory really fast. If you're not dialed in and managing and -- but it's measured in weeks, and I apologize, we don't have it at our fingertips. But a 30-45 day window wouldn't surprise me, but I just don't have the accurate number at my fingertips." - Fastenal CEO Dan Florness

The housing market also showed signs that it was transitioning from being “red hot” to just “pretty strong.” Low inventory continues to boost home prices.

 "The housing market is returning to sustainable levels and oh what a relief it is” - Redfin CEO Glenn Kelman

“From a macro perspective, the housing market remains strong, and these continue to be the best of times. Demand has been consistently strong, while the supply of new and existing homes remains limited. Since new home construction cannot ramp quickly enough to fill the void of the production deficit that persisted over the last decade, short supply is likely to remain for some time to come.” - Lennar Corp Executive Chairman Stuart A. Miller

 "Demand continues to outpace supply. And in many communities, we continue to sell out of homes as soon as we release them due to existing waitlists. However, we are seeing signs that demand levels are normalizing from the surge that began last year." - LGI Homes CEO Eric Lipar

Technology:

Apple’s changes to IDFA on iOS devices were one of the key tech trends that we followed during the quarter. Facebook and Snapchat both reported significant headwinds from Apple’s changes. In particular, Facebook said that updating its system to respond to the changes may be a multi-year process. The IDFA switch appears to have created some winners and losers.

"There are 2 big challenges coming from these iOS changes. The one is targeting and one is measurement…So we have to rebuild our targeting and optimization systems to work with less data. So this is a multiyear effort" - Facebook COO Sheryl Sandberg

“Our advertising business was disrupted by changes to iOS ad tracking that were broadly rolled out by Apple in June and July. While we anticipated some degree of business disruption, the new Apple provided measurement solution to not scale as we had expected, making it more difficult for our advertising partners to measure and manage their ad campaign for IOS” - Snap CFO Derek Andersen

The winners are those who depend less on identity as part of the value prop of the platform. For instance, Google saw less impact from the changes than others because it relies on search.

“Starting with the iOS 14 changes. So overall, as we said, we're pleased with the strength across our business in the third quarter, it was broad-based, it was global. In terms of the iOS 14 changes, specifically, they had a modest impact on YouTube revenues, that was primarily in direct response” - Alphabet CFO Ruth M. Porat

"...the disruption and the noise around the loss of cookies and device IDs like Apple's IDFA, in general, is a net benefit to Roku" - Roku SVP Scott Rosenberg

There was also the big change in Facebook now being called Meta. There has been increased talk from tech companies on the Metaverse and the opportunities and challenges that lie in it.

“...this entire idea of metaverse is fundamentally this: increasingly, as we embed computing in the real world, you can even embed the real world in computing -- one of the metaphors that I always use which is helpful is that as both an outside-in and inside-out -- So that concept of being able to be in a virtual space again as an avatar ultimately as a hologram, interact with others, have spatial relationships with others because of those things like spatial audio, I think are just other additional forms of what we’ve all gotten used to today withvideo-based meetings. So video transcending to 2D avatars and 3D immersive meetings is probably a practical way for us to think about how the metaverse really emerges” - Microsoft CEO Satya Nadella

“Over the next decade, these new platforms are going to start to unlock the kinds of experiences that I wanted to build since before I even started Facebook. Along with those social experiences, I expect a massive increase in the creator economy and amount of digital goods and commerce. If you're in the metaverse every day, then you'll need digital clothes and digital tools and different experiences. Our goal is to help the metaverse reach 1 billion people and hundreds of billions of dollars of digital commerce a day” - Facebook CEO Mark Zuckerberg

“Beyond creating branded digital worlds or items, brands are also showing up in metaverse environments through digital advertising. Anzu, for instance, places ads that track viewability in real-time within gaming environments across mobile, console and now recently Roblox for brands like WarnerMedia and Paramount+. The ads mimic real life and blend into gameplay -- so billboard ads or branded clothing appears in-game just as it would in real life. These can be bought programmatically, or dynamically in Roblox, at CPMs ranging from $6 to $12 across platforms” - The Trade Desk

Industrials and Transport:

Supply chains are still very challenged and we have not yet read any quotes that suggest things are improving. Semiconductor shortages are expected to last into 2022 and auto inventories are not expected to rebound soon either.

“Disruptions to our supply chain intensified as the quarter progressed and along with municipal delays, resulted in our build times extending by about 2 weeks sequentially. This pushed many deliveries into our fourth quarter and will similarly delay in some fourth quarter deliveries into our 2022 first quarter.” - KB Home CEO Jeff Mezger

“…we missed the low-end of our third quarter delivery guidance by 600 homes, delivering 15,199 homes... it's a reflection of the current market conditions. The supply chain for both land and construction is significantly stressed, and that will continue into the fourth quarter and beyond.” - Lennar Executive Chairman Stuart Miller

“Unfortunately, due to ongoing supply chain challenges, we were not able to ship everything we anticipated in the second quarter, which caused some of our revenue to shift out of the quarter.” - Steelcase CEO Jim Keane

Logistics is an area of the supply chain that is especially pressured. Ports are clogged and there aren’t enough truck drivers or containers to support the growing demand for shipping goods around the country.

"Containers are scarce to find; the container costs have increased 8X. Ocean freight has increased 8X. A typical container used to cost a couple of thousand dollars is now $16,000. So, there's a lot of stress on logistics, lot of stress on the supply chain situation." - Enphase Energy CEO Badri Kothandaraman

“Container capacity, container rates and port congestion continue to be areas of concern. We expect these issues to continue well into 2022. Our container prices on the spot market continued to increase during the quarter.” - Haverty Furniture President Steven Burdette

The simmering global supply chain issues seem to have impacted ad spend.

"These factors have been compounded from many advertisers by major global supply chain issues and labor shortages, which have lost many consumer businesses with less inventory. This has reduced their appetite to generate demand from consumers, which has impacted advertising spend. Businesses in every region and across a range of verticals have been affected. At the same time, we've also seen some impact from COVID surges around the world in places like Southeast Asia." - Facebook COO Sheryl Sandberg

Health:

The global vaccine push continues to be the most interesting story in the healthcare industry. In the United States, many people have begun receiving Covid booster shots.

“We haven't been in a pandemic in the modern history before, at least of that magnitude. And the virus a very smart virus. So it's mutating and it's trying to find ways to prevail. So the name of the game right now and what Pfizer needs to do is to stay ahead of the virus. What we are doing is we are constantly monitoring the efficacy of our vaccine. And the reason why we went out with the news that we think we need a vaccine -- a booster vaccine was because we did see that the immune responses were waning and the protection was waning” - Pfizer CEO Alberta Bourla

"I think what we're planning for quarter four is I think we'll still continue to see micro-surges in cases. There will always be little hot spots. Hospitals are still going to experience some labor challenges. We don't see that getting better in the near-term" - Johnson & Johnson EVP Ashley McEvoy

Materials & Energy:

Oil prices have rebounded along with the rest of the economy. However, the world continues to focus on investing in renewable sources of energy in order to fight climate change. The switch to electric vehicles seems to be taking on an air of inevitability. The EV charging infrastructure is a major constraint of growth though.

 "E-mobility has fully arrived in our everyday lives. However, the charging infrastructure isn't keeping up…The growth of electric cars already exceeds the growth of current charging capacity in Germany by a factor of 5. Many EU countries still don't have a charging network at all. Without a coherent framework, no technology can be implemented or become widely accepted. This applies to both e-mobility and hydrogen." - BMW Chairman Oliver Zipse

“It is my belief that the next 1,000 unicorns -- companies that have a market valuation over a billion dollars -- won’t be a search engine, won’t be a media company, they’ll be businesses developing green hydrogen, green agriculture, green steel and green cement," - Blackrock CEO Larry Fink

A fusion startup called Helion Energy raised $500 million and said that we would have electricity from fusion by 2024.

 "This funding ensures that Helion will be the first organization to generate electricity from fusion -- Our 6th prototype demonstrated that we can reach this pivotal milestone. In just a few years we will show that the world can count on fusion to be the zero-carbon energy source that we desperately need.” - Helion Energy Founder and CEO David Kirtley

In summary:

Heading into the quarter our biggest questions revolved around whether or not the world would fully return to its pre-Covid norms. From what we read it appears that old habits die hard. In the US the memory of Covid is fading fast. The workplace is one of the few areas of the economy that is showing a long-lasting impact from Covid. Workers seem to like working from home and while offices are open, it’s not clear when or if people will return. This could have major implications on demographic patterns over time.

“...what we're starting to accept is that there has been a fundamental change in what the job seekers are looking for from work, and that's evidenced not just by the reluctance of the unemployed to resume searching for work but also the great resection where people who were currently employed who now feel safe are now leaving their jobs at record levels. You're seeing an employer reaction to that, that is predictable with a record increase in wages, a record number of jobs that offer benefits, flexible schedules, and/or even remote work. So it seems like the job market is still in a state of flux as it reacts in response to what happened during COVID. And it's yet to settle down and play itself out.” - Zip Recruiter CEO Ian Siegel

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