Weekly Reading for 8/1/2022

The past week was a busy one for earnings with over 40% of S&P 500 companies reporting! As we continue to sift through all the earnings here are some notes from Walmart and Visa:

Visa:

• Management saw no reductions in consumer spending levels because of reduced consumer confidence or a weakening economy up to this point
• Saw strengthening trends in affluent spending, particularly in restaurants and travel
• No noticeable changes in overall basket sizes due to higher inflation
  • Management did note that it is possible/likely that consumers are making substitutions and “trading down” to lower-cost/off-brand goods to offset the impacts of inflation and maintain overall spending levels and basket sizes.
  • If the ‘basket’ does get smaller however that would be cause for concern and will be something we will continue monitoring closely going forward.

Walmart:

In their earnings call management cited 3 main reasons for increased costs compressing margins. Wage item expense, Fuel and supply chain costs, General merchandise costs

• Digging deeper on general merchandise costs rising
  • Target had a similar message a couple months ago. Effectively these companies overbought general merchandise which could be anything from kitchen ware, patio furniture, casual clothing, etc. This over buying was a result of companies expecting pandemic spending habits to continue. Now these companies are trying to work through this overstock by offering noticeable discounts on these items. Walmart cited general merchandise inventory increased over 30%!
    • Was it reasonable to expect people to purchase multiple sets of outdoor chairs?
    • Did they expect the government to keep printing stimulus checks indefinitely to fund these discretionary purchases?
  • Also, consumer spending habits changed quicker than expected due to inflation
    • As inflation has increased, consumers have pivoted their spending habits to core goods.
    • From CEO Douglas McMillon “Inflation is lifting the average ticket and our transaction count in stores went up slightly versus last year. Overall basket size is up as you would expect, but units per basket are down a bit.”
      • Similar to Visa’s message it is encouraging to see that even though the spending habits are shifting, consumers are still able to purchase similar amounts of goods

    Ultimately this was a long-winded way of saying that big box stores have excess inventory on general merchandise and are trying to move it quickly. With football season right around the corner. If you have the discretionary income, it is probably a good time to stock up on folding tables for those Bills games!!

    

Goehring & Rozencwajg Quarterly Commentary

Longer read but this is some of the most in depth research on natural resources out there. Even though it is a couple months old, a lot of the insight they provide especially regarding LNG and agriculture is still very much applicable.

• The Europe natural gas story has dominated the headlines given the Russian conflict. As the title suggests a gas crisis seems to be growing in the US that is getting overlooked.
• US natural gas is dominated by production from just 3 fields!
  • 2 fields Marcellus and Hayneville produce almost 40% of US gas
  • According to the G&R industry modeling Marcellus has produced almost 50% of its recoverable reserves. And Hayneville will hit that 50% mark by October 2023
    • On top of this most of the recovered gas has been done through high grading – instead of improving drilling techniques E&P companies will target extracting the easier to acquire Tier 1 gas first
    • There is still a lot of gas left in these fields, but it is concerning to see some of biggest US fields beginning to plateau.
    • The US has enjoyed decades of natural gas oversupply which has kept prices low
      • What happens as production is not able to keep up with demand and we pivot from surplus to deficit?
  • The oil-to-gas ratio gas been historically high in the US ever since the shale production ramp in 2013
    • “A barrel of oil has six times the energy content of an MMBtu of natural gas, so the “normal” ratio of oil to gas should be 6:1. Instead, the oil to gas ratio averaged 20:1 between 2016 and 2021, even as crude prices fell.”
    • “Now compare that to outside of North America, where natural gas trades at an oil-to-gas ratio of 3:1.”
    • “In our 35 years investing in global energy markets, we have never seen such a wide disparity.”
  • The headlines are focused on the price of oil but natural gas is just as important
    • “We consume nearly as much energy via natural gas as we do via crude oil, although it is usually an afterthought.”
      • Watching the price at the pump go up and down is a very tangible measure for oil. Recognizing how costs are affected from industrial and electric power due to natural gas price increases is more indirect and nuanced.
        • 70% of US natural gas consumption in 2021 came from Industrial and Electric power!
      • We had begun to see natural gas prices increasing even before the Ukrainian conflict. As this conflict continues and the US is pressed upon more for global demand, we will likely continue to see Nat gas prices continue to increase (5-yr US Nat gas chart below from FactSet)