Why Mitsubishi Motors’ Crash Assessment Doesn’t Look Good
Mitsubishi’s shares haven’t really become a bargain
In just three trading days, a fuel-economy scandal has destroyed 42% of Mitsubishi Motors’ market value. Yet the shares haven’t really become a bargain—even under the generous scenario that the scandal is contained to what the company has so far outlined.
Here’s what investors know for sure. Mitsubishi manipulated fuel-economy tests for four minicar models, all sold in Japan and amounting to 625,000 vehicles produced since 2013. And the car maker will stop production of these models.
The company also has more than 450 billion yen ($4 billion) net cash. After Friday’s fall, the company trades for just 10% more than the net cash it had on its balance sheet at the end of December. That doesn’t mean it’s cheap enough, though.
First, consider the impact on earnings. Shipments of the models in question will evaporate, and sales of other models will suffer due to Mitsubishi’s tarnished brand. Citigroup estimates operating profit will drop nearly a third in the current fiscal year. Though not apples to apples, that should translate into a drop in earnings before interest, tax, depreciation and amortization. Based on S&P Global Market Intelligence average analyst estimates, that would mean an Ebitda of 147 billion yen.
Before this news, investors valued Mitsubishi’s shares at a cash-adjusted market value around 2.3 times Ebitda. Haircut this valuation by 25%, since its now-weaker brand means weaker long-term growth. That yields an enterprise value of 250 billion yen.
Nomura reckons a maximum cost of 166,000 yen per vehicle. Goldman Sachs estimates 200,000 yen. Be conservative and go with 250,000 yen per vehicle, and that means a total payment of 156 billion yen.
Subtract that payment from net cash, and it would leave 295 billion yen. Then add the new net cash to enterprise value, and the company should be worth 10% more than Friday’s close.
That shouldn’t be enough to tempt bargain hunters—who must also consider what they know they don’t know. Employees used an incorrect method for Mitsubishi’s fuel-economy tests, a practice that began in 2002, not 2013, and could end up affecting more than two million cars sold in Japan since then. A 250,000 yen-per-car cost for a hypothetical two million vehicles would imply a 59% downside for the shares.
Another unknown is whether this scandal spreads overseas, where nine of 10 Mitsubishi nameplates are sold. The company says it is checking its sales abroad. Lawsuits and fines in a litigious country such as the U.S. could seriously impair Mitsubishi’s balance sheet, not to mention earnings if production halts.
Mitsubishi Motors has a lot more to discover about its problems before its shares find a bottom.
But how much of the latest building boom will actually improve the life of Londoners?©Michael Collins
FARRINGDON The new nine-storey Goldman Sachs HQ will occupy around 850,000 sq ft in EC1
It’s often the disappearance of the familiar that makes us notice the city around us. We walk the same streets every day, no longer really noticing the buildings that define them. Then a hole appears, an open wound in the urban tissue. New views are revealed, naked backs exposed. In 19th-century Paris, photographers rushed to document the last moments of medieval streets and intimate alleys. In London, most urban construction today is perceived as a nuisance rather than a sign of progress, greeted not with nostalgia for the old but frustration in the moment: a closed Tube station, a road diversion, a racket. As the capital grows, it goes through waves of rebuilding, each purporting to address a dominant issue. In the late 19th century it was slum clearance; after the second world war it was the rebuilding of a city devastated by bombing as a physical expression of a new welfare state; in the 1980s the rebuilding was an effort to revitalise the city as a global financial centre. And now — what exactly?
The current phase of construction, which will change the London skyline more radically than any previous rebuilding, is predicated on real estate as investment. More than 400 towers of 20 storeys or more, either under construction or in the planning process, will reshape a city that once revelled in its low-rise silhouette of slate rooftops and chimneys. At the same time, entire new strata are being carved out beneath the pavements. Residents of affluent neighbourhoods have been protesting about the disruption caused by the construction of a new generation of mega-basements, multiple-storied subterranean spaces containing pools, gyms and home-entertainment suites. These may be eye-wateringly expensive to build but, thanks to hyper-inflated property prices (Mayfair developments have been reaching upwards of £5,000 per sq ft), they add far more to a property’s value than they cost to construct. Together the two phenomena might be seen as a kind of privatisation of the sky and the soil, a vertical extrusion upwards and downwards of the ownership once conferred in only two dimensions on an Ordnance Survey map.
The story is not only about private property, however. The biggest holes that have appeared in central London during the past few years have been those dug to build the £15bn Crossrail project, which, by the end of 2019, will provide a 100km rail link from Reading and Heathrow in the west, under central London, to Shenfield in the east. Chasms have opened up in some of the city’s most tightly knit and atmospheric neighbourhoods. Big chunks of Soho have been chewed into mulch by concrete shears, and paper-thin Victorian façades now shiver in the wind generated by Centre Point (itself being converted into apartments). The blocks around Denmark Street, once the hub of the music business with its guitar shops, recording studios and basement clubs, have been fast disappearing. This messy neighbourhood, so dirty and incoherent it was overlooked by developers, is now being repackaged as a piece of prime real estate with added musical nostalgia. The hole south of Oxford Street, carved into Soho, appears vast beside the delicate grain of the neighbouring Georgian elevations, the scale of the structural intervention a shocking disruption to the slightly seedy, dilapidated grid.
©Michael Collins
SMITHFIELD Beneath the Victorian market hall, work is under way on the £15bn Crossrail project linking west and east London
The city’s next blockbuster infrastructure project is the “super sewer”, or Thames Tideway Tunnel (due to begin on site this year), a subterranean cesspit that will handle storm surges and stop raw sewage being sent into the Thames. The £4.2bn project is being developed by a consortium of private investors, a vehicle for guaranteeing future income from London water bills. The taxpayer, as ever, provides the backstop should anything go wrong. The new consortium is called Bazalgette Tunnel Limited but in borrowing one of London’s great engineering names, it reveals its inadequacy.
©Michael Collins
OXFORD STREET The western entrance to the new Tottenham Court Road Tube and Crossrail stations will also bring 500,000 sq ft of retail, office and residential space to the edge of Soho
In the 1860s, when Joseph Bazalgette designed the sewers that still serve the city, he conceived a Thames Embankment that not only prevented the river from flooding but would also create a grand new public space for promenading, returning a once purely working river to the public realm. This drain in turn provided space beneath it for the new underground system to be built simultaneously. So the by-products of the city’s drainage system were the world’s first underground railway and an expanded public space that radically redefined the city’s relationship with its river.
©Michael Collins
OLD STREET YARD A mixed-use development by Derwent London to include the White Collar Factory, a 16-storey office building in EC1
In London’s last great rebuilding, in the mid-20th century, many mistakes were made — urbanism delegated mainly to traffic planners, terraces needlessly demolished, poor quality social housing, grim commercial canyons. But there was also an idea that the city was being rebuilt for the benefit of its inhabitants as visionary public projects such as the Southbank Centre, the Festival Hall, National Theatre and the Barbican emerged. Social housing, from Ernö Goldfinger’s Trellick Tower in the west to his Balfron Tower in the east, with a landscape of fine quality council housing in the middle, facilitated a genuinely socially integrated city. The 1964 GPO Tower shot from the West End like a rocket, a revolving restaurant at its top — a self-conscious symbol of the Labour government’s embrace of the “white heat of technology”. By the mid-1970s, south London’s skyline was dominated by the 34 storeys of Guy’s Hospital Tower, the tallest hospital building in the world — a resolutely public structure. There were commercial blocks too — including the once notorious Centre Point — but most buildings sticking up above the city’s skyline were council housing towers, public assets giving the poorest the finest views over London. Now, hospital buildings are giving way to investment pads at Barts Square (part of the site of the city’s earliest hospital, founded 1123) or the former Middlesex Hospital now Fitzroy Place. Public to private.
©Michael Collins
HANOVER SQUARE A joint development in Mayfair will provide a new Crossrail station, along with offices, shops, restaurants and a public square in W1
What, we might wonder, will be the public benefits of the huge new layers of 21st-century construction? Where is the vision for a grand new public infrastructure following in the wake of Crossrail? Times have changed. The sites that now appear as gaping wounds will be stitched not with public space or buildings but with vehicles for private profit.
London’s departing mayor Boris Johnson came to office in 2008 on a promise not to let London turn into “Dubai on Thames”, in contrast to his predecessor Ken Livingstone, who had been pro-development and pro-tower. Yet Johnson’s record has been precisely the opposite of his sloganeering, an execrable legacy of ill-planned developments and poorly-designed towers scattered incoherently across the city. The impression is of a capital in thrall to capital, property as asset class — what the former City planner Peter Rees termed “safe-deposit boxes in the sky”.
©Michael Collins
BART’S SQUARE The scheme for 236 apartments and 25,000 sq m of office, retail and restaurant space on land previously owned by Bart’s Hospital in the heart of the City
Today, the tower at Guy’s Hospital is dwarfed by the neighbouring Shard, a 310m skyscraper with the “View from the Shard” at its peak. This was billed as a new public space for London, a new vantage point: family ticket (two adults and two children) £74.95. Below this are super-luxury apartments (between £30m and £50m each), a five-star hotel further down (Shangri-La Suite, yours for £14,000 a night) and at the bottom a mediocre and incomplete remodelling of London Bridge Station, which seems to put the station at the service of the building rather than the building at the service of the city.
©Michael Collins
CANAL REACH Looking out over King’s Cross towards the City of London and the Shard, with the London Eye on the far right
Despite its faults, the Shard at least has ambition and a considered, perhaps even elegant, profile. Compare it with some of the other towers rising across the city — buildings as objects that seem to have nothing to do with the sites on which they sit or the contexts they will so drastically alter. Or take the vast groundscraper on Farringdon Street, a new building for Goldman Sachs, a crushing piece of visual branding that will dominate a neighbourhood that once accommodated everything from making pianos to printing and clockmaking.
©Michael Collins
MAYFAIR The main ventilation shaft for Bond Street Crossrail station, looking south over Brook Street
There can, of course, be no construction in the city without demolition. The sudden exposure of a site leaves the surrounding buildings looking vulnerable. It gives a glimpse of the parts of structures never meant to be seen from the street. It opens strange new views that can leave the onlooker surprised, even disoriented. Exposed interiors, often complete with wallpaper and fireplaces stuck halfway up walls, are held up with steel bracing or clad with waterproofing or tarps. Period façades are retained in a futile gesture to maintain the texture of the historic city while the rear is bulked up with steroidal development. But one thing these gaps also reveal is the astonishing complexity and ad hoc construction of fragments of a city that have been added to and adapted over centuries. Often the original bones are impossible to detect, obscured by decades of accretions. These were almost always buildings with elegantly clothed façades; the architecture was only for the front. Yet these Georgian and Victorian creations have managed to survive through the centuries, accommodating adaptation and reuse almost in every decade; from residential to commercial, workshops to studios, shops, bars and bedsits as needed. Their replacements will be tailored to specific uses — global retail chains, top-end apartments and commercial units with big floorplates — overscaled developments with a projected lifespan of no more than 25 years. How will these new buildings be able to change in time, to accommodate unforeseen uses?
©Michael Collins
BART’S SQUARE A retained façade on the site of the new retail, office and residential development adjacent to Bart’s Hospital in Smithfield, EC1
The city has its own kind of intelligence; it understands the need for front and back: tarty shopfronts and swanky apartments as well as back alleys and dingy basements where workshops or music venues might establish themselves, largely unseen. It creates density, but it is a density of use as much as of population and it is an endangered ecosystem. Of course, every city changes and has to adapt. Nostalgia is an easy emotion and some of the capital’s new buildings are sophisticated and elegant. Perhaps these gaps are temporary illustrations, memento mori, reminders of the natural state of a city as an organism in flux. London continues to attract people from all over the world — even if the young, the creative and the unsure are increasingly pushed to the margins. There was never a perfect moment. Yet walking through its fast-changing streets there is a sense that the new is inevitably bigger than the old; glassier, shinier, but rarely better. “The chief function of the city,” wrote the urban historian Lewis Mumford in 1961, “is to convert power into form, energy into culture, dead matter into the living symbols of art, biological reproduction into social creativity.” The chief function of London, today, it would seem, is to convert space into money. Is that ambition enough?
China’s total debt rose to a record 237 per cent of gross domestic product in the first quarter, far above emerging-market counterparts, raising the risk of a financial crisis or a prolonged slowdown in growth, economists warn.Beijing has turned to massive lending to boost economic growth, bringing total net debt to Rmb163tn ($25tn) at the end of March, including both domestic and foreign borrowing, according to Financial Times calculations.
Such levels of debt are much higher as a proportion of national income than in other developing economies, although they are comparable to levels in the US and the eurozone.
While the absolute size of China’s debt load is a concern, more worrying is the speed at which it has accumulated — Chinese debt was only 148 per cent of GDP at the end of 2007.
“Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth,” Ha Jiming, Goldman Sachs chief investment strategist, wrote in a report this year.
The country’s present level of debt, and its increasing links to global financial markets, partly informed the International Monetary Fund’s recent warning that China poses a growing risk to advanced economies.
Economists say it is difficult for any economy to deploy productively such a large amount of capital within a short period, given the limited number of profitable projects available at any given time. With returns spiralling downwards, more loans are at risk of turning sour.
According to data from the Bank for International Settlements for the third quarter last year, emerging markets as a group have much lower levels of debt, at 175 per cent of GDP.
The BIS data, which is based on similar methodology to the FT, put Chinese debt at 249 per cent of GDP, which was broadly comparable with the eurozone’s figure of 270 per cent and the US level of 248 per cent.
Beijing is juggling spending to support short-term growth and deleveraging to ward off long-term financial risk. Recently, however, as fears of a hard landing have intensified, it has shifted decisively towards stimulus.
New borrowing increased by Rmb6.2tn in the first three months of 2016, the biggest three-month surge on record and more than 50 per cent ahead of last year’s pace, according to central bank data and FT calculations.
Economists widely agree that the health of the country’s economy is at risk. Where opinion is divided is on how this will play out.
At one end of the spectrum is acute financial crisis — a “Lehman moment” reminiscent of the US in 2008, when banks failed and paralysed credit markets. Other economists predict a chronic, Japan-style malaise in which growth slows for years or even decades.
Jonathan Anderson, principal at Emerging Advisors Group, belongs to the first camp. He warns that banks driving the huge credit expansion since 2008 rely increasingly on volatile short-term funding through sales of high-yielding wealth management products, rather than stable deposits. As Lehman and Bear Stearns proved in 2008, this kind of funding can quickly evaporate when defaults rise and nerves fray.
“At the current rate of expansion, it is only a matter of time before some banks find themselves unable to fund all their assets safely,” Mr Anderson wrote last month. “And at that point, a financial crisis is likely.”
Others believe the People’s Bank of China will retain its ability to ward off crisis. By flooding the banking system with cash, the PBoC can ensure that banks remain liquid, even if non-performing loans rise sharply. The greater risk from excess debt, they argue, is the Japan scenario: a “lost decade” of slow growth and deflation.
Michael Pettis, professor at Peking University’s Guanghua School of Management, says rising debt inflicts “financial distress costs” on borrowers, which lead to reduced growth long before actual default.
“It is wrong to assume that ‘too much debt’ is bad only if it causes a crisis, and this is a typical assumption made by almost every economist," Prof Pettis wrote in a draft of an forthcoming paper shared with the Financial Times.
“The most obvious example is Japan after 1990. It had too much debt, all of which was domestic, and as a consequence its growth collapsed.”
Distress costs include increased labour churn as employees migrate to financially stronger companies; higher financing costs to compensate for increased default risk; demands for immediate payment from jittery suppliers; and loss of customers who worry a company may not survive to provide aftersales service.
Many are now concerned that China’s debt could lead to a so-called balance-sheet recession — a term coined by Richard Koo of Nomura to describe Japan’s stagnation in the 1990s and 2000s. When corporate debt reaches very high levels, he observed, conventional monetary policy loses its effectiveness because companies focus on paying down debt and refuse to borrow even at rock-bottom interest rates.
“A financial crisis is by no means preordained but in our view, if losses don’t manifest on financial institution balance sheets, they will do so via slowing growth and deflation, à la Japan, a path China arguably already is on,” Charlene Chu, senior partner at Autonomous Research Asia, wrote recently.
Despite increasing attention to the risk from China’s rising debt, there is surprisingly little consensus over basic facts such as how much China actually owes. The increasing complexity of China’s financial system adds to difficulties in producing an authoritative estimate.
The Financial Times’ estimate of Rmb163tn ($25tn), or 237 per cent of gross domestic product, at the end of March uses data from China’s central bank on so-called “total social financing” (TSF), which covers lending to the non-financial sector by both banks and non-banks. It then adds finance ministry and National Audit Office data on, respectively, central and local government debt. Finally, data from Wind Information, a Chinese financial database, is used for government bonds issued in early 2016 but not yet reflected in NAO and finance ministry figures.
The FT’s methodology is similar to that of the Bank for International Settlements, which in September released a database that tracks total debt in 42 big economies. In addition to drawing on more recent TSF and NAO data, the FT seeks to eliminate possible double-counting in the BIS figures. Double-counting may arise from local governments’ use of special-purpose vehicles to borrow. Such borrowing is counted as corporate debt in TSF data but as government debt by the NAO.
Some analysts estimate that China’s debt load is significantly higher than both the FT and BIS estimates. Awidely cited report by McKinsey last year placed China’s debt at 282 per cent of GDP by mid-2014, an estimate that includes debt owed by financial institutions.
Many analysts believe the McKinsey estimate suffers from significant double counting, since the money that banks and other financial institutions borrow is lent on to non-financial borrowers. But some analysts also believe that for China, including at least some financial debt is necessary to capture shadow-bank lending that is not included by TSF.
Rodney Jones, principal of Beijing-based Wigram Capital Advisors, provides Asia macro analysis to billionaire investor George Soros, who last week likened China’s economy to the subprime-saddled US before 2008. Mr Jones says Chinese banks use investments in wealth management products to disguise corporate loans as financial debt. Based on a detailed analysis of financial statements by more than 100 banks, he estimates China’s debt-to-GDP ratio at 280 per cent at the end of 2015.
“The financial engineers have run amok again. They’ve run amok in the US and they’ve run amok here. That’s what George sees," says Mr Jones.
Barrons weekend summary: positive on MAR, MHK, TYL; cautious on AFSI
Cover story: Barron's Big Money poll found that 38% of money managers are bullish or very bullish about the prospects for stocks in the coming months, down from 55% in last fall's survey and 45% last spring; most managers see only a modest rise in stock prices in the year ahead, with the potential for dramatic, if temporary, setbacks.
Features: 1) Positive on MAR: Tie-up with HOT offers financial and strategic benefits, and could generate annual cost savings of about $250M; the deal will broaden Marriott's reach with the loyal customers who constitute 50% of its volume, and shares could rise 30% during the next 18 months; 2) Positive on MHK: Amid a healthy housing sector, company-the top flooring business in the U.S.-should get a boost, and shares could rise 20% or more during the next year; 3) Positive on TYL: Little-known Texas-based software firm sells to local governments and has a reliable revenue stream, and a recent pullback is a good opportunity for investors; 4) Cautious on AFSI: Investors have largely ignored concerns about insurance company's accounting and the adequacy of its reserves, but even with a recent drop they should move carefully.
Trader: Wall Street is still debating whether the market is overvalued or fairly valued, says Malcolm Polley of Stewart Capital Advisors, who says it's definitely not undervalued; James Paulsen of Wells Fargo Capital Management says defensive stocks have been giving way; Positive on FMC: Cyclical, short-term problems have hammered the midsize chemicals firm, but its shares now look undervalued by as much as 50%; Positive on ARRS: Shares of broadband equipment and cable-box maker are down amid skepticism about the effect of potential changes in FCC rules, but they're cheap at a recent $22.
Interview: Ron Baron of Baron Capital, a growth investment firm with $23B in 13 funds overseen by 10 managers, seeks companies with competitive advantage and good management (picks: H, INOV, TSLA, MANU).
Alternative Investments: Profile of Randy Swan of Swan Global Investments, who stays invested in the S&P 500 but uses long-term index put options to protect the portfolio against declines, with the biggest benefits seen during drops of 20% or more.
Small Caps: Cautious on CKEC: Amid a shareholder dispute about the proposed AMC takeover, investors might want to book some profits but hold onto the majority of their shares on the chance of a sweetened offer; Cautious on CFX: Shares are up 60% since January, but there may not be much room for improvement during the next year, and they look ripe for profit-taking.
Follow-Up: SHW: Paint company has excellent growth prospects, especially because of its acquisition of VAL, but shares are close to being overvalued, investors seeking access to the housing sector might be better off with MHK; Cautious on HCA: Hospital company has strong free cash flow and a good balance sheet, but amid a turbulent political landscape, "taking profits now and buying on the next dip could be the healthiest move."
European Trader: Positive on HSBC, BCS, BNP Paribas, Societe Generale: Stocks of European banks may be risky, but their subordinated debt could be a good investment, offering yields between 5.5% and 10%.
Asian Trader: Cautious on ATHM: Investors in the U.S.-listed Chinese company, a provider of online ad services for car makers and dealers, could take a hit if a management buyout goes through.
Emerging Markets: With its political turmoil and ongoing battle against deadly terrorism, Pakistan may seem like a country to avoid, but it has a long-term growth story, with an economy expanding 4.5% annually.
Commodities: Drivers this summer will find diesel to be cheaper than gasoline at the pump; each fuel has its own supply-demand picture, with divergent outlooks heading into summer.
Streetwise: "For contrarians, knowing what other investors don't own can be just as important as knowing what they do own"; A list of "fading stars" kept by Lori Calvasina of CS includes CMG, M, WFM, and BIIB-though the latter could be on the upswing.
Market Rally Begs the Question: Time to Take Profits?
Some overheated issues tumble, in what might be a sign of what’s ahead for the market.
From the worst of times to the best of times, it has been a tale of two markets in what has been a dickens of a year so far.
After the lousiest start for stocks and risk assets in memory, there has been “one mother of a reflation trade going on here in market-land,” as David Rosenberg observes from his perch as chief economist and strategist at Gluskin Sheff in Toronto.
That has vaulted last year’s losers to the top of the leader boards among various asset classes. According to numbers kindly passed along by Cliff Noreen, president of Babson Capital Management, emerging market bonds have been the big winners so far in 2016, with a return of 13.4%—a stark reversal of 2015’s negative 14.9%, which made them the second-worst group last year. Last year’s cellar dwellers, emerging market equities, which also lost 14.9%, are in third place in 2016, with a positive 7.4% showing.
Second place this year is held by international bonds, up 10.5%, after being third from the bottom in 2015. And high-yield bonds are up 6.5%, putting them in fourth place, after having been fourth from the bottom last year at a minus 4.5%.
All these asset classes share a common thread: They have followed the 60% recovery in crude-oil prices from the abyss in the mid-$20-a-barrel range to the low $40s. And that owed less to the Organization of Petroleum Exporting Countries’ cartel than to the money cartel—the world’s central banks.
For lack of a better term, the apparent “understanding” among the monetary authorities in February—to loosen the deflationary vise of a rising dollar and falling commodity prices that was squeezing the global economy—sowed the seeds of this reversal. And being spring, those seeds have sprouted. This have been depicted graphically by Evercore ISI technical guru Richard Ross. His charts show breakouts in myriad members of the energy-stock group, including long-depressed oil-services stocks and master limited partnerships.
That has been accompanied by recoveries in beaten-down commodity-related currencies, from the Canadian and Australian dollars to the Russian ruble, the South African rand, and even Brazil’s real (notwithstanding the crisis there, demonstrating how economics can trump politics). Gold and silver also have rallied, with gold stocks in bona fide bull territory; the SPDR Gold Trust exchange-traded fund (ticker: GLD) is 20% above its late-2015 lows.
Not surprisingly, a change of sentiment is accompanying these price swings. At the depths earlier, Rosenberg recalls, risk assets were discounting recession and deflation. A few months later, they’re being bid up in a supposed reflationary boom. “The truth, as usual, likely lies near the middle of these boundaries,” he sagely observes, but prices can overshoot in both directions.
Signs of correction of some of the more recent positive excesses began to emerge last week. Friday, in particular, saw what happens when growth stocks aren’t showing growth, according to Doug Kass, head of Seabreeze Partners and an irrepressible market commentator.
Among those getting whacked at the end of the week: Alphabet (GOOGL), the parent of Google, which lost 5.4% Friday on weaker-than-expected earnings, and Microsoft (MSFT), down 7%. Outside of tech, Starbucks (SBUX), fell 4.9%, and Visa (V) shed 2%.
Interestingly, the victims have extended to so-called safe stocks that have been bought as bond substitutes, and at fancy prices for rather plain companies. Kleenex maker Kimberly-Clark (KMB) fell 3.7% Friday; Reynolds American (RAI) took a 3% header Thursday, while other supposedly stable staples such as Spam maker Hormel Foods (HRL), Coca-Cola (KO), Campbell Soup (CPB), and PepsiCo (PEP) lost a year’s worth of dividends or more last week. Ditto the Utilities Select Sector SPDR ETF (XLU).
Before Friday’s retreat, Rosenberg wrote, “much of this rally, especially this last whippy part of it, has been short-covering,” evidenced by the sharp shrinkage of negative bets in the Standard & Poor’s 500 futures and options. That had brought the major averages within a few percent of their records. “It would seem prudent to take advantage of this unexpected turn of events,” he continues, to “take some profits (or minimize losses)…you couldn’t have possibly have ever thought were possible in February when every Street economist was tripping over him (her) self to be the next one to publish an ever-higher risk of recession.”
To which he adds J. Pierpont Morgan’s trenchant observation: “I never became wealthy by buying at the lows or selling at the highs. I was there merely from the middle 60%.”
And it’s also appropriate to ponder such things at this time of year. A glance at the calendar shows that it’s about to flip, calling to mind the old saying about selling in May and going away.
THE CALENDAR ALSO SHOWS that the Federal Open Market Committee gets together again this week, in what will be another instance of the market watching what the panel might say, even though it’s as certain as anything can be in Washington that the Fed won’t do anything about interest rates.
At the March 15-16 confab, Janet Yellen & Co. let it be known that the central bank envisions only two rate hikes for the rest of 2016. The previous indication that four increases were on the table was a big reason for risk markets’ swoon through mid-February. The FOMC’s change of heart (and head), along with increased accommodation from its counterparts at the European Central Bank, the Bank of Japan, and the People’s Bank of China, further helped spur the subsequent rally in risk assets.
Now, what to do? A poll of Fed watchers by Reuters found that they expect the FOMC to hold rates steady at this week’s meeting, and to implement its second increase later. The initial liftoff in the federal- funds interest-rate target, to 0.25%-0.5%, took effect last December. Fifty of the 80 economists polled thought that the next hike would come at the June 14-15 meeting.
As has been the case consistently, the fed-funds futures market is forecasting that rates will stay lower for longer. It’s pricing in just a 19.6% probability of a June move, according to Bloomberg calculations, with odds of a hike to 0.5%-0.75% or higher only getting significantly better than even money by Dec. 13-14, when the market discounts a 62.6% probability. Cynics will undoubtedly point out that the election will be well behind us by then.
One of the main reasons that so many economists see the Fed moving to raise rates so much sooner is the perceived robust state of the labor market. While the headline jobless rates hovers around 5%, what has caught many economists’ attention is the record-low number of filings for unemployment insurance.
In the latest week, jobless claims fell to the lowest level since 1973, with some 247,000 queueing up at state unemployment offices. And some also point out that this low level of claims comes against a much larger working-age population than existed 43 years ago. Thus, the implication is that the labor market is even stronger than the claims data suggest.
Other, subjective aspects of the changing nature of the jobs market, however, have gotten less attention. The popular label is the “gig economy,” which contrasts with the norm of another era: a full-time job, with benefits, that folks used to keep for years.
Part-time employment has become much more a norm than in previous economic cycles, JPMorgan economist Jesse Edgerton writes in a research report. That the elevated portion of involuntary part-timers “has been so impervious to the significant progress made in the labor market over the last six years suggests to us that it may prove more structural than cyclical,” he writes. That structural shift, he continues, appears to have coincided with the passage of the Affordable Care Act, aka Obamacare.
The ACA included a requirement that employers provide health insurance to employees who work 30 or more hours per week. A chart included with Edgerton’s report shows that “passage of the ACA preceded a large and unprecedented shift from workers working more than 30 hours a week to just under 30 hours. We continue to believe that the ACA can explain a significant number of the ‘extra’ involuntary part-time workers.”
So, how are folks making ends meet? Bianco Research thinks that they’re working in the gig economy as free-lancers, Uber drivers, and the like. Bureau of Labor Statistics data don’t show it, but the Internal Revenue Service numbers show a sharp rise in filings of 1099-Misc forms for 2014 (the most recent year for which numbers are available). These are required if someone is paid more than $600 in a year. The Bianco folks surmise that those in the gig economy are working multiple gigs, and thus filing more than one 1099-Misc form.
The real question is whether, given the prevalence of part-timers and gig workers, weekly jobless claims convey the same meaning as they did in cycles past.
Fed Chair Yellen has been less rigid about the central bank’s policy goals of full employment and 2% inflation than some of her colleagues. Indeed, she has made global financial conditions a key consideration in her decisions, along with domestic targets.
New highs in the stock market may be more of a spur to raise rates than a fall in jobless claims.
MORE THAN ONE PRINCE died in the past week. Seth Glickenhaus, gentleman, scholar, social conscience, philanthropist, and one of our favorite stock pickers, died at age 102 on April 16. The founder of Glickenhaus & Co. was managing his investments until the end. In his last conversation with his daughter, Nancy, he asked repeatedly if there was news on any shipping stocks. They were always among his favorites.
Marriott Shares Could Rise 30% in the Next 18 Months
The Starwood acquisition broadens reach with loyal customers, who make up 50% of room volume.
Marriott International has gained a reputation among investors as the country’s best-run lodging company thanks to a superior management team, a fee-focused business model that delivers strong free cash flow, and an upbeat growth outlook linked to the development of hotels around the world.
Those attributes have been obscured lately as Wall Street has focused on the company’s pursuit of Starwood Hotels & Resorts Worldwide (ticker: HOT) after Marriott (MAR) got locked in an unexpected bidding war with China’s Anbang Insurance Group. Marriott won when Anbang dropped out of the contest on March 31. That paves the way for Marriott to purchase the Starwood, the operator of Sheraton, W, and St. Regis hotels, for $13 billion in stock and cash in a transaction expected to close by midyear.
The Starwood deal offers financial and strategic benefits. Marriott plans to generate annual cost savings now estimated at $250 million, and more importantly, it should be able to generate more revenue by offering an expanded hotel portfolio to the 76 million members of the companies’ combined loyalty programs.
Marriott, whose brands range from the no-frills Courtyard and Fairfield Inn to the high-end Ritz-Carlton, will become the world’s leading lodging company, with 5,700 hotels, 1.1 million rooms, and a market value of $27 billion.
Now trading at around $67, Marriott shares look attractive at 18 times estimated 2016 earnings of $3.76 a share. Investors are more focused on post-merger net income in 2017 and 2018. Marriott is projected to earn $4.39 a share in 2017 and $5.15 in 2018. Its shares fetch a reasonable 13 times estimated 2018 earnings—appealing for a company that looks capable of generating 15% to 20% annual growth in earnings per share in the next few years, in line with its performance in the past five years.
“The beauty of the Marriott business model is that it’s almost entirely fee-driven,” says Nomura hotel analyst Harry Curtis. “That makes it far less cyclical than lodging companies that own more real estate. It doesn’t make Marriott recession-proof, but it does make the company more recession-resistant.” Curtis carries a Buy rating and sees the stock hitting $87 in 18 months.
Under CEO Arne Sorenson, Marriott has returned about 100% of its net income to shareholders. Most has come via share buybacks, with Marriott now paying a modest 1.5% dividend. Marriott has that flexibility because virtually all its net income translates into free cash flow.
Marriott owns few of its 4,424 hotels. Its “asset light” strategy is to have others put up the capital to build hotels while it takes a franchise fee of 5% to 6% of revenues in return for providing reservation systems and other services. About 57% of its hotels are franchised and owner-managed. The remaining 43% are franchised and managed by Marriott, including nearly all of its Ritz-Carlton hotels.
Marriott intends to sell Starwood’s owned hotels, including the St. Regis in Manhattan, and move to a Marriott-style franchise and management model. Marriott also aims to revitalize Starwood’s largest brand, Sheraton, while continuing to nurture hot concepts like the W boutique hotels. Starwood operates about 1,300 hotels.
“The merger is a little less compelling financially” than it was originally, Sorenson told Barron’s last week. “But it’s still very attractive. Starwood has a nice collection of brands. We see a tremendous opportunity. We can’t wait to get going.” That opportunity includes combining Marriott’s industry-leading 55-million-member loyalty program with Starwood’s 21-million-member one. Loyalty customers are critical to both chains, accounting for half of all room volume.
Starwood members should benefit from access to Marriott’s much larger network of hotels, many of which are in destinations where Starwood has none. Marriott loyalty customers will be even more incentivized to book rooms because they will be able to use points for stays at Starwood’s high-end properties like the St. Regis hotels in New York and San Francisco and its Hawaiian resorts.
THERE ARE POTENTIAL procurement and other benefits as well. Sorenson says that 16 minutes after the original Starwood deal announcement at 6 a.m. on Nov. 16, 2015, he got an email from PepsiCo (PEP) boss Indra Nooyi; Coca-Cola (KO) CEO Muhtar Kent contacted Sorenson later that day. Why? Pepsi is the primary soft-drink provider to Marriott; for Starwood, it’s Coke. Both companies realize that Marriott probably will choose just one after the deal.
Sorenson was also contacted that day by American Express (AXP) CEO Ken Chenault and JPMorgan Chase (JPM) CEO Jamie Dimon. AmEx is the credit card partner for the Starwood Preferred Guest loyalty program, while JPMorgan and Visa (V) have the Marriott Rewards credit-card relationship. Ultimately, AmEx or JPMorgan probably will get all the business.
MARRIOTT SHARES are 20% below their peak of $85 set last April, reflecting general weakness in the lodging sector amid concerns about the health of the global economy. International terrorism fears haven’t helped. The company cut its 2016 RevPAR guidance earlier this year to 3% to 5% from 4% to 6%. (RevPAR, or revenue per available room, is a key industry financial measure.) Investors also weren’t thrilled that Marriott sees the revised Starwood deal as neutral to earnings per share in 2017 and 2018. As for Airbnb, it’s not viewed as a major threat, as most of Marriott’s business is related to corporate, not leisure, travel.
Investors may be taking a wait-and-see approach to the merger. As a result of the Anbang bidding war, Marriott had to increase its Starwood offer by $1.7 billion, or about $10 a share, and include a greater cash portion. As a result, the company plans to halt its stock-buyback program until the fourth quarter in order to bring down its debt/Ebitda ratio to maintain its investment-grade debt rating. (Ebitda is earnings before interest, taxes, depreciation, and amortization.) The buybacks could resume in earnest next year.
Globally, the outlook for the lodging industry looks good thanks to growing travel demand from developing countries; in Asia alone, an estimated 100 million people step onto a plane for the first time each year. Almost half of Marriott’s development pipeline is international, with 27% of the total coming from Asia. The domestic situation also looks favorable, with expected annual demand growth of just over 2% this year and next outpacing supply gains.
Marriott is poised to capitalize on these trends while continuing to reward shareholders with strong capital returns.
WHITBREAD’S SHARES (WTB.UK) could perk up more than 25% if it executes a sale and leaseback on some of its hotel assets and a spinoff of its Costa Coffee chain.
The stock has lost more than a quarter of its value in the past 12 months, partly because investors worry about the capital-intensive nature of the hotel business. Whitbread hasn’t done a sale and leaseback in three years, but one done now could help it realize the value of its assets.
A spinoff of Costa is only a medium-term possibility. The chain is performing well, and analysts at Credit Suisse project compound annual growth of 14% from this year through 2019—a rate higher than that of Starbucks (SBUX).
At Friday’s close of £38.87 ($55.88), Whitbread trades at 15.6 times estimated 2017 earnings of £2.49 a share. On a sum-of-the-parts basis, the stock could be worth £51.40.