Hope everyone had a nice weekend!
New Reshoring Centers Shaping Up- Mexico Edition
“If the pendulum continues to move for a while in the direction I foresee, there will be ramifications for investors. Globalization has been a boon for worldwide GDP, the nations whose economies it has lifted, and the companies that reduced costs by buying abroad. The swing away will be less favorable in those regards, but it may (a) improve importers’ security, (b) increase the competitiveness of onshore producers and the number of domestic manufacturing jobs, and (c) create investment opportunities in the transition. For how long will the pendulum swing away from globalization and toward onshoring? The answer depends in part on how the current situations are resolved and in part on which force wins: the need for dependability and security or the desire for cheap sourcing.” -Howard Marks, Oaktree Capital Mgmt
As brilliantly described by Oaktree Capital Management’s Howard Marks in his letter “The Pendulum of International Affairs” (link below), key geopolitical developments often times lead to huge swings in the pendulum of globalization trends and countries’ interdependence. Examples cited in his letter include the current Ukraine war and Europe’s dependency on Russian natural gas and energy commodities, US dependency on Taiwan for advanced semiconductor production, and the manufacturing shift of durable goods to China. Marks cites how offshoring undoubtedly had substantial contribution to the low level of goods inflation experienced in the U.S. over the last 40 years, with the prices of durable goods falling over 40% over the 25 years between 1995 (rise of Chinese exports) and 2020. However, things are and will continue to change in the global economy and, as pointed out by Howard Mark’s, shrewd investors seek out investment opportunities for companies benefiting from these changes.
Figures released from the US Commerce Department last week showed that for the first time in more than two decades, Mexico last year surpassed China as the leading source of goods imported to the United States. Specifically, the value of goods imported to the United States from Mexico rose nearly 5 percent from 2022 to 2023, to more than $475 billion while at the same time, the value of Chinese imports imports tumbled 20 percent to $427 billion. The last time that Mexican goods imported to the United States exceeded the value of China’s imports was in 2002. Major products now produced in Mexico for import to the US include automobiles and auto parts, medical equipment, electrical equipment, machinery, and metallurgical products, among others.
Since first implemented by the Trump administration in 2018, US President Joe Biden has not reverted Chinese import tariffs which has continued to erode the cost competitive advantage from companies importing in China. In addition, ever since the global pandemic supply chain interruptions and resulting spiral of shipping and transportation costs, there has been a push by companies to seek suppliers in allied countries, coined as “friend-shoring”, or simply to return manufacturing to the United States or “reshoring”. Also, legislation such as the the United States-Mexico-Canada Agreement (USMCA) and the Mexican government’s tax incentives and breaks, have provided manufacturers opportunities for duty-free imports, and financial support for infrastructure development to attract and support manufacturing operations. In fact, according to a survey completed last year by Gartner of small to medium sized businesses last year, 88% of SMBs plan to switch at least some of their suppliers to ones either in the U.S. or close by and 45% plan to switch all of them, coming out of the COVID-19 pandemic. Reasons cited continue to include shorter supply chains, the United States-Mexico-Canada-Agreement trade pact, lower labor costs in Mexico and the North American transportation infrastructure.
Who stands to benefit? Most immediately, railroad and freight companies tapping into new supply lanes and expanding their service offerings. If you were to pull up and read recent earnings calls from railroad and freight operators, the new mega trend to expand and invest in supply and transportation offerings from Mexico has dominated analyst questions and earnings call discussion. For example, Union Pacific, the leading rail provider to and from the U.S./Mexico border, just launched a new intermodal service with from Mexico and the southeastern U.S. in October 2023, tapping into demand for service from Mexico’s industrial markets to Florida,, Georgia, and North Carolina. This comes after Canadian National earlier last year teamed up with Union Pacific and Ferromex owner Grupo México Transportes to launch its Falcon Premium Service which created new service routes from Canada to Mexico with a connection in Chicago. In fact, one of the biggest surprises early in 2024 has been signs of potential bottoming activity in transports (IYT) which had a weekly breakout last week. This historically has been a bullish development for US GDP and economic growth. Trucking spot rates have thawed and are now up $.23/mile or 15% since November and the ISM Manufacturing gauge of new orders, shifted into expansion territory last month after spending 16 months in contraction. Finally, the Logistics Managers Index has now been above the 50 mark for the 5th month out of 6 with every index component expanding for the first time since Sep 2019. The charts of names such as TFII, NSC, CP, CSX, ARCB, SAIA, XPO, ODFL, KNX, JBHT, and others tell the whole story that “destocking” and the post-COVID freight recession may in fact be showing signs of bottoming.
Below are some recent snippets from railroad operators earnings calls this past quarter:
“I talked about the service product that we have, and we're not waiting around for the near shoring to happen. We've seen some wins with us having the fastest product coming out of Mexico, especially in time-sensitive products like auto parts, again, a daily service….And so we're encouraged by that. We're bullish about that. We are talking to customers about that. We're putting as much as we can on the network….So again, coming out of Mexico, it's a great franchise for us. We've got six borders that we can get in and out of Mexico. So great product and great franchise.”- Kenny Rocker, VP Marketing & Sales Union Pacific (UNP)
“Automotive revenues continue to be strong, up 22% and 19% volume growth, another record quarter for our automotive franchise. Our automotive franchise is benefiting from new business, solid continued production from our OEMs and steady equipment supply driven by improved operations and cycle times, particularly in Mexico. And I'm really bullish on our steel franchise between not only our Mexico production facilities, supporting the growth down there in the automotive industry and other industries, but also our steel facilities in the US and Canada. So that's an area I keep an eye on it. I think you're going to see some strong growth”- John Brooks, EVP and CMO Canadian Pacific Kansas City Limited (CP)
Howard Marks Oaktree Letter:
https://www.oaktreecapital.com/insights/memo/the-pendulum-in-international-affairs
Quotes of the Week
1) “I'd like to begin with three transformative megatrends that are driving the market. Last week, at Perform, we called them Waves. First, cloud modernization continues to drive workloads to the cloud. Second, the AI revolution is sweeping across industries with the opportunity for enormous advancements in innovation and productivity. And third, the escalating threat landscape is increasing the need for more sophisticated cyber security protection. These megatrends are occurring amidst an increasing focus by organizations to leverage digital transformation to drive business transformation, but they also bring sizable challenges such as an explosion of data, a massive increase in its complexity, disconnected tools, and a need for better analytics. And it is these challenges, especially with the exponential increase in AI workloads, that have moved observability and application security from optional to mandatory, but not all observability and application security tools are created equal.”
-Rick McConnell, CEO Dynatrace Inc (DT)
2) “But there’s no question that demand for BEVs [battery electric vehicles] has slowed….We think the bridging strategy is certainly going to be as hybrid... So when we step back and look at it, right now, in California, we can’t even get chargers installed at our locations, because there’s not power available to obviously supply them. We see that not only on the retail car side, but also on the truck side. I think we’re at an inflection point, where early on we had – customers that were early adopters certainly went out, bought the BEV, those early adopters now already have them, and you’re getting to the point where you’re trying to convince the customer to find their first BEV or their last ICE. And so, going back to what Roger said about our overall BEV sales in the U.S. being in California, earlier this week talking to our management team there, we’re starting to think that that market is getting saturated. When you look across the balance of the country, certainly the BEV adoption percentages are a much lower rate.”
-Roger Penske (CEO) Richard Shearing (COO), Penske Automotive Group (PAG)
3) “Q3 marked our 20th consecutive quarter of net sales growth, putting e.l.f. Beauty in a rarefied group of consistent, high growth consumer companies. We're one of only five public consumer companies out of 274, that has grown for 20 straight quarters and averaged at least 20% sales growth per quarter. In color cosmetics, we continue to significantly outperform the category. In Q3, e.l.f. Cosmetics grew 46% in tracked channels, 23 times category growth of 2%. We increased our share by 305 basis points. Out of nearly 800 cosmetics brands tracked by Nielsen, e.l.f. is the only brand to gain share for 20 consecutive quarters. We've more than doubled our market share from about 4.5% in 2019 to 10% in 2023, placing us as a number three brand nationally. In Target, our longest-standing national retail customer, we're the number one brand with about a 19% share, nearly double the share we had in Target just a few years ago….. Our results continue to fuel progress with national retailers. e.l.f. is the most productive cosmetics brand at our top three customers in the U.S., Target, Walmart, and Ulta Beauty. We're pleased to announce that we'll be expanding space for e.l.f. in spring 2024 with CVS and in summer 2024 with Walmart.”
-Tarang Amin, CEO e.l.f. Beauty, Inc. (ELF)
Some interesting charts from this past week:
1) New-Tenant Repeat Rent Index
Housing is the most important single expense for most Americans and it comprises roughly 1/3 of the total Consumer Price Index (CPI) alone, thus the Federal Reserve’s measurements of housing costs is a highly critical element of measuring inflation. After observing that the CPI rent index often differs from alternative measures of rent inflation produced by ApartmentList, Zillow, and others, new Cleveland Fed research has noted that new-tenant rent inflation may provide better real time information about the future direction of all-tenant rent inflation and should be integrated into inflation forecasts and monetary policy decisions. This index seeks to leverage lease turnover in order to track rent growth in units that change tenants to obtain a more real time pulse on house rental prices are trending. Their research supports that the New Tenant Repeat Rent Index leads CPI rent inflation (as currently calculated and reported) by four quarters, suggesting a significant decline is ahead in reported headline owners equivalent rent CPI inflation figures.
2) Commodities Divergence- Going In a Different Direction
Since peaking in June 2022, the Bloomberg Commodity Spot Index (blue) is now down by 31% and has shown a significant divergence to the rally in the S&P 500 (orange). The Bloomberg Commodity Spot Index appears to reflect a global recessionary trajectory led by recessionary leanings in Europe and deteriorating economic growth in China hampered by its debt-fueled property crisis. This comes as China continues to slip deeper into deflation with its consumer prices falling 0.8% YoY in January, the fastest pace since the 2007-2008 Great Financial Crisis. In addition, China’s producer price index fell 2.5% in January, marking 16 straight months of deflation for factory-manufacturing costs.
3) Snap (SNAP) Stock Based Compensation
Snap shares fell almost 35% on heavy volume this past week after releasing their quarterly earnings report. Snap continues to handsomely pay its owners and employees as stock-based compensation (SBC) remained elevated at $333 million, or roughly a shocking 25% of revenue. Snap's diluted shares outstanding count is up by more than 50% since its 2017 IPO meanwhile the company is spending nearly 40% of its revenue on share buybacks, clearly unsustainable. Stock based compensation expense has now increased 72% from 2020 while EBIT has declined 30% YoY over each of the past 2 fiscal years as Snap continues to struggle with ways to monetize its social media users.
Stocks I’m Watching
Honorable mentions that didn’t make the final cut: CELH, VRNS, FROG, DY, EXI, FTV, OTIS, CSWI, VRNS, IDXX, NFLX, CMI, ARCB, CIBR, CP, CSX, EMR, TW, PRU, JBHT, TREX, AZEK, CNI, FTI, APP, VVV, AFG, MUSA, WMS, MDY, CXW, CLH, PLAY, IWO, CNI, SXC, WSM, CELH, UGA, NVMI, AMPL, TREE, BSY, FR, OWL, LNW, BECN, ONTO, FORM, CAMT, NET, WCC, DCI, IOT, FRSH, GOOGL, AMPH, AMAT, TRV, AXP, PATH, CROX, MCO, BSY, NUE, NU, USAP, BLK, AAON, ABBV, TXT, MPWR, MANH, BLTE, APPF, ROAD
1) Hudson Technologies (HDSN)
Hudson Technologies, Inc. a refrigerant services company, provides solutions to recurring problems within the refrigeration industry in the United States.
Hudson is showing signs of breaking of a weekly bull flag (up Friday on over 3X relative volume) and this small cap looks primed for its next leg up. Hudson Technologies is the largest player in the U.S. refrigerant reclamation market (35% market share) and effective January 1st of this year, the amount of hydrofluorocarbons (HFCs) allowed to be produced has now fallen to 60% of baseline due to AIM act legislation. This legislation is expected to increase the need for recycled and alternative refrigerants to fill the gap and Hudson expects to realize stronger margins on reclaimed refrigerants as gross margins for the product are typically closer to 50%. Hudson sports a robust balance sheet having recently paid off its term loan debt and over the last 15 months, has now repaid $100 million in term loan debt (expected savings to the company of over $10 million of annualized interest.) Currently trading at forward P/E of just 8X, consensus estimates call for 19% and 21% EPS growth in 2024 and 2025, respectively. Hudson also could be a takeout target for interested industrial or HVAC peers. Earnings expected 3/1.
2) Weatherford International (WFRD)
Weatherford International plc, an energy services company, provides equipment and services for the drilling, evaluation, completion, production, and intervention of oil, geothermal, and natural gas wells worldwide.
While technology names continue to be in favor, the seasonal upswing in crude oil prices typically begins in the late February timeframe. Weatherford is a a diversified international energy servicer who has aggressively shored up its balance sheet (since 2018, the company's net debt has decreased from $7.4 billion to $1.3 billion today) and after rocketing higher the past 2 years, price has now consolidated sideways since August of last year as the rising 40WK moving average plays catch up) and has formed a weekly bull flag. Currently trading at forward P/E of just 8X, consensus estimates call for 25% and 21% EPS growth in 2024 and 2025, respectively. After a 6% jump in WTIC last week, crack spreads continue to rise, suggesting more tightness in the physical crude oil market than what current prices suggests. Weatherford on its conference call this week suggested than its expects mid teens oil services growth spearheaded by the Middle East, North Africa, and Asia border geography, with countries like Saudi Arabia, Kuwait, UAE, Oman, Australia, and Malaysia setting the pace. Interesting enough, other oil and gas sector names such as refiners (MPC, PSX) and exploration names such as IMO, PBR, FANG, PR, and others have resisted price declines while oil has so far been stuck in a trading range.
3) Carlisle Companies (CSL)
Carlisle Companies Incorporated operates as a manufacturer of engineered products in the United States, Europe, Asia, Mexico, the United Kingdom, and internationally.
Carlisle has seen steady accumulation the past 5 weeks culminating with a strong weekly base breakout after its earnings call last week on heavy volume. Carlisle recently agreed to sell its Carlisle Interconnect Technologies (CIT) business to Amphenol Corp (APH) (expected to close at the end of 2nd quarter), for over $2B as it transitions itself to become a pure play building products supplier. Carlisle repurchased 3.5 million shares for $900 million over the past year and 2024 guidance calls for mid-single-digit revenue growth, expanding EBITDA margins, and ROIC in excess of 25%. Carlisle reiterated on its earnings call that they expect destocking to be behind them and expects to use the $2 billion of proceeds from its CIT sale to allow for flexibility to execute further share repurchases and fund high-returning capital allocation priorities. Carlisle has repurchased roughly 24% of its shares over the past 10 years through its buyback programs. Finally, Carlisle is also a dividend aristocrat with a history of 47 consecutive annual dividend hikes and a 5 year dividend growth CAGR of 16%. A pullback to its rising 10WK moving average could offer possible entry.
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