Earnings, earnings, earnings
As we predicted earlier, the big banks reported better-than-expected deposits and quite good Net Interest Income (NII) (JP Morgan’s grew +78% to $9.2B as an effect of higher interest rates). We continue to rate JPM as a pretty strong buy and it came through here – earnings of $12.6B (up 52% from the first quarter of 2022). Revenue of $38.3 billion (up 25% from the year-ago period). Wells Fargo (WFC) earned $5 billion, Citigroup earned (C) $4.6 billion, and PNC (PNC) earned $1.7 billion. It’s a closely watched earnings quarter for the banks, after the collapse of SVB – we continue to be of the opinion that the banks are far better capitalised than in 2008 and so-called deposit “flight” has been fairly contained. We looked at CCC credit spreads from this year and the GFC (basically, Lehman Brothers). Spreads this year increased +100 bps at most. In the GFC they increased +1000 bps. And remember – this is for the very worst of the worst of credit tranches – +100 bps is a storm in a teacup and we continue to be quite bullish on banks as a whole.
CCC Spreads GFC – +1000 bps !
CCC Spreads – now – only + 100 bps
Longer for higher
We keep beating this drum but here’s JP Morgan CEO Dimon on the prospect of higher rates for longer –
“So, there is a risk of higher rates for longer. And don’t just think of just the Fed funds rate because I think you should — for our planning, I’d be thinking more about, it could be 6 and don’t — and then think about the 5- and 10-year rate, which could be 5. And I think if those things happen, I’m not saying they’re going to happen. I just think people should prepare for them“
We think when the best bank operator in the US speaks, it pays to listen – Dimon’s comments, while upbeat for the whole earnings call, came with a healthy side of caution – as we have been writing to you on an almost weekly basis, the prospect of higher rates for longer is very real.
Apple
Apple’s computer shipments fell 40% in the first quarter. We think you ought to be cautious when it comes to Apple – it’s a great company – truly best-in-class – but news that caught our attention came from Foxconn’s March sales which were down 21% (Foxconn is one of Apple’s major suppliers). Notably, the company sees iPhone 14 panel shipments falling 40% in April – they fell 23% lower in March. The read-through here doesn’t bode that well for Apple – iPhone sales still consist a large part of Apple’s revenue. Lowering our EPS estimate to $1.39 per share – we expect disappointment which has not been priced in yet. A lot of these sales will affect next quarter’s results so we don’t expect to see as much in this quarter’s earnings. But something to be aware of. We still like Apple – it’s best in class – but it’s still a consumer company and at some point those chickens have to come home to roost.
Hermès
Hermès sales were up 23% YoY, signaling that the rich keep spending. We saw this on Friday with LVMH – here’s another signal. Hermès of course makes Birkin bags, which are highly desirable and actually go up in value. Margins continued to be exceptional – 40.5% – when you make Birkins, you can more than keep pace with inflation. The reason we highlight this is because it highlights the peculiarities of this economic slowdown – the middle class have been hit hard while spending continues unabated by the very well off. Hard to fault results like this – margins actually grew 120 bps or so from 39.3% last year to 40.5% this year.
How to buy a £6.8bn supermarket chain for £200M
Incredible piece in today’s FT that examines how the billionaire Issa brothers bought UK supermarket chain Asda for effectively £200M. It’s a wild story. Here’s the chart:
The brothers already own EG group, one of the world’s largest petrol pump operators. EG group is already heavily indebted. The brothers lent money to themselves. EG’s parent company, Optima Bidco, lent more than half a billion quid to Bellis Topco, which is the parent company of Asda. To raise money for the loan, Optima sold preference shares (shares which pay a fixed rate, and have no voting rights) for €405mn and $316mn in 2020, which it then gave £580mn of to Bellis Topco, meaning the brothers were left with £100mn each to find.
Consider for a second how wild this is. You are a mechanic, maybe, and your mechanic shop is owned by MechanicCo. You decide you want to buy a plumbing business, which you will buy with a company called PlumbingCo. You don’t have enough cash — so you sell shares that don’t have voting rights in MechanicCo and then lend the money to your new company, PlumbingCo. Then you’ve basically completed a leveraged buyout of the plumbers by lending yourself money. This is how most leveraged buyouts work, though usually with a third party, not your own company, but the structure is basically the same. There’s a lot of things that can go wrong! For instance, the rate you pay for those preference shares might be due to increase to 10% this year, and 12% the year after. And maybe your initial business isn’t doing that well, so you are having to eat more of your profit to pay those loans.
This is – we’re simplifying – almost exactly what has happened with Asda. EG has £1.7bn in outstanding preference shares, and they’re set to increase to 10% this year. EG’s core underlying earnings fell 15%. On the other hand, you have Asda, which took on £3.7bn of junk-rated debt to help the Issa’s pay for the company. There’s a lot of debt going around, and it’s all very unstable. The brothers may have overextended themselves, and one possible solution may be to sell part of EG to Asda. This is again, wild — EG borrowed in order to buy Asda, and Asda buying EG would be buying debt it owes to itself. It’s an interesting story, and it begs the question how many other leveraged operations of the last decade are there? Either way, it’ll be messy.
Week Ahead
Monday
NZ Food Price Index
US Earnings: Charles Schwab
Tuesday
US Earnings: Johnson and Johnson, Netflix, Bank of America, Boeing and Goldman Sachs
Australia, RBA minutes
Wednesday
CPI (Inflation) data from the UK and Eurozone
US Earnings: Tesla, Morgan Stanley, and IBM
Thursday
Aus: Earnings from Bank of Queensland, and quarterly update from Rio Tinto
US Earnings: Adobe
Friday
Aus: Quarterly Update from Woodside Energy and BHP
US Earnings: Proctor and Gamble, L’Oreal