Earnings Takeaways and Becoming Data Dependent

Companies Highlight Persistent Demand

Now through January, with over 170 companies from the S&P 500 and roughly 77% of those companies reporting positive earnings surprise, we’ve picked up on a few key themes.¹ Omicron did contribute to a slowdown in January, but the case count is improving, thankfully, and many company operations are back to normal. In UPS’s case, “business has come back roaring.” Omicron likely had a short-term impact on productivity and consumer spending, and Q1 GDP growth may be slower (we expect around +2% annualized), but we haven’t heard any indication from companies about softening demand and continue to expect a rebound in GDP growth in Q2 and the second half 2022.

Elasticity of demand has been particularly strong when you consider the pace of rising consumer prices. Companies have indicated expected tailwinds from higher prices and more efficient supply chain management in the latter half of 2022 as demand stays elevated. Stanley Black & Decker (SWK) announced new price increases of 5-10%+ for the current quarter, while Proctor & Gamble (PG) cited “a lower reaction from the consumer in terms of price elasticity than what [they] would have seen in the past” amid price increases to each of their ten product categories. Jamie Dimon summarized many of the drivers for consumer demand recently on CNBC, saying that “the consumer has $2 trillion more in their balance sheets, their home prices are up, asset prices are up, jobs are plentiful, wages are going up [and] they’re spending… 25% more than spending pre-Covid.”  This is consistent with our analysis, which we have written extensively about in the past year.

Free Cash Flow Contributing to Debt Paydowns, Shareholder Returns and Capex

An effect of higher pricing and lower inventory builds is that free cash flow has grown significantly across industries. McDonald’s (MCD) grew free cash flow +25% vs. 2019, while Chevron (CVX) generated free cash flow 25% higher than their previous annual high. Companies are using free cash flow to improve balance sheets, return cash to shareholders and invest in capex. We welcome a strong capex cycle as it will help overall economic growth.

Paying down debt was a notable trend in 2021, and now companies are positioned with stronger balance sheets for future growth. Paying down debt and returning cash to shareholders are not mutually exclusive — UPS (UPS) improved its debt-to-EBITDA ratio from 3.6x in 2020 to 1.9x in 2021 by paying down debt, while returning over $3.9 billion of cash to shareholders. Higher 2021 free cash flow enabled Chevron to pay down debt, increase its dividend and engage in share buybacks throughout the year.

Chart 1: Lower Total Debt from Paydowns²

Chart 2: Better Leverage (Lower Net Debt / EBITDA) and Higher Dividends³

Higher free cash flow and better visibility is resulting in large material increases of dividend and repurchase programs. Stanley Black & Decker announced that its $4 billion share repurchase program will include $2-2.5 billion of repurchases in Q1. Halliburton (HAL) announced a 166% dividend increase, UPS announced a 49% dividend increase, Levi Strauss (LEVI) announced a 25% dividend increase and American Express (AXP) announced a 20% dividend increase.

Corporate investment towards capex is a trend we’re watching in 2022 as companies focus on improving their efficiency to capitalize on the strong demand environment. While job openings continue to remain at record levels (+61% y/y), companies are spending on automation, technology and logistics as they manage both a tight labor market with wage pressures and a complex supply chain with elevated freight and materials costs. Analysts project S&P 500 capex growth in 2022 to be the highest one-year rate since 2011.

Chart 3: S&P 500 – Higher Free Cash Flow and Capex⁴

Supply Chains: Challenges Remain, Though Visibility Improving

We’re beginning to see a light at the end of the tunnel for the drawn-out supply chain challenges that have created headwinds in the form of low inventory levels and cost pressures. Companies have shared expectations that supply challenges will continue, but ease in the second half of 2022. Easing supply chain challenges will improve productivity and support volume growth.

Stanley Black & Decker estimates that 90% of their price/cost headwinds will occur in the front half of 2022. Union Pacific (UNP) said that “embedded in the expectation for stronger growth in H2 is the recovery in the supply chains, and that includes the chip shortages.” Stabilizing the supply chain remains a top priority for many companies. Caterpillar (CAT) mentioned that “when the supply chain bottlenecks begin to ease, we expect to be well-positioned to increase our production to more fully meet demand and gain operating leverage from higher volume.”

The combined expectations for persistent demand —particularly in themes like DIY, construction, autos, re-opening — higher prices and production efficiency (from capex) will allow companies to unlock further earnings growth when supply chain challenges do begin to materially ease.

Companies are better positioned entering 2022 in their supply chain management than they were in 2021. While supply chain challenges remain, we continue to keep our ear to the ground, listening for easing pressures — particularly in semiconductors, autos and aerospace, and at the ports.

Staying Data Dependent

In addition to all the commentary we receive from companies during earnings season, we continue to pay attention to what the economic data is telling us. We will continue to do so throughout the year to confirm whether what we’re hearing in company expectations is actually taking place. Will supply chains materially ease in the second half? Will consumer demand remain elevated? Does additional capex generate incremental productivity and volumes?

Job openings were reported at 10.9 million in December, remaining near a record high. This is likely to continue to place pressure on wages and companies relying on increased labor for better productivity. This is good for the consumer, who has plenty of jobs available and can earn a higher wage.

Manufacturing ISM reported a 20th consecutive month of economic expansion in January. In addition to expansion of new orders and production (leading indicators), the prices paid index rose more than expected, indicating that supplier pricing power continues to rise. Respondents to the ISM survey share a challenging production environment with significant backlogs, long lead times and a tight labor.

Finally, we received the December core PCE price deflator last week, which was +4.9% y/y. Much of this is due to higher materials, freight and labor costs. All to say that inflation remains hot, and we’ll watch carefully for indication from the Fed on rate hikes and how the yield curve reacts. The key will be for the Fed to execute a soft landing, lowering inflation while maintaining strong economic demand.

Chart 4: Core PCE Price Index Highest Level Since 1983⁵

Stephanie Link: CNBC TV Schedule

Sources

1. Bloomberg
2. FactSet (chart)
3. FactSet (chart)
4. FactSet (chart)
5. FactSet (chart)

Disclosures

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.