Charts of the Month - February '23
Starbucks Profitability, Mediterranean Crossing, China Trade Deficit, Natural Gas, Retail Investor Flows, EPS Quality Deteriorating, Zombies, Negative Yielding Debt
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Starbucks: From Headlines to the P&L
Starbucks received a lot of attention last week for launching a new coffee drink with olive oil in it.
The announcement has some sticker shock for sure as it sounds a bit weird at first, but if you take a step back, it’s not that crazy. Bulletproof Coffee introduced us to oil in coffee and fourth wave coffee is full of single origin, light, and highly floral noted coffees, which could also pass as a description of a good olive oil. But hey, headline sellers need to sell headlines, right?
What we thought would be a more interesting and less wasteful way to spend your 10-minute read with us, is to dive a bit deeper into the Starbucks 10K to explore how 2022, with its onslaught of geopolitical and macro cross currents, manifested itself onto the P&L of a company that’s been subjected to just about every headwind the last three years had to offer.
Starbucks is a multinational corporation (HQ’d in the U.S., with corporate offices across EMEA, India, Australia, China, and the U.K., and 32,000 stores in 80 countries) selling a commodity-based product whose price is heavily influenced by geopolitical and macro events, weather, human rights and social forces, cross-currency translations, and a whole host of micro drivers that only a select few firms in the world are subject to. Combined, these forces create an interesting case study, especially for us here at Lykeion where our focus is on the convergence of business, finance, and geopolitics. Basically SBUX.
In their latest report, Starbucks categorically breaks down where they saw operating margin compression and expansion, which, on a net basis, saw a 250 basis points contraction (i.e., they were 2.5% less profitable in 2022 than in 2021).
This is a visual representation of how headlines (inflation, wages, commodity cycles, etc.) materialize onto a P&L.
- “Increase in Retail Store Partner Wages” – Roger covers employment and wages as the key catalysts for timing an equity market bottom in this Macro Report.
- “Commodities and Supply Chains” – Jacob covers commodities pricing in our first Research Publication and in the Investment Case for Latin America. Remember, Brazil is the largest coffee exporter in the world and a country Jacob is quite bullish on.
- I discussed the effects of Operating Leverage which, commodity-based companies are heavily subjected to – the upside and the downside of it.
- “Strategic Pricing” – is a corporate way of saying “we raised prices on consumers to keep up with the increases in input costs we had to eat”. This is inflation 101 and we’ve covered it in just about every piece we’ve written over the past year – so just go browse the archive and spend a few hours there…
Someone get Schultz a double shot of EVOO...
Recorded Deaths in the Mediterranean
From our friends over at International Intrigue (definitely sign up if you haven’t already, it’s top-flight geopolitical commentary):
“Headline: At least 73 dead in the latest Mediterranean shipwreck.
Briefly: More than 73 people are believed to have died at sea during an attempt to cross the Mediterranean and reach Europe. Only seven managed to return to Libya, from where their small boat departed sometime earlier this week.
Some context: Libya is a common departure point for folks trying to reach Europe: it’s close, and local law enforcement is near-zero. Unfortunately, this latter point means human rights abuses are common, perpetrated by both traffickers and the Libyan authorities.
Zooming out a little: migration is one of the toughest challenges for governments today. On the one hand, the UN was founded on the principle that countries govern themselves. And for many countries, that means controlling their own borders.
On the other hand, there are now 90 million people forcibly displaced around the world, and the Refugee Convention protects the right to seek asylum.
Intrigue’s take: The geopolitical angle to all this is a doozy. Countries that find themselves along the migration path (like Turkey, Morocco and Belarus) have been accused of 'turning the migration tap' on/off to maximize their leverage over places like the EU.
Others that seek to manage the issue through bilateral deals (like the UK-Rwanda arrangement) can find themselves under the blowtorch of global scrutiny. And meanwhile, governments seen as sitting on their hands put themselves at the mercy of (angry) voters. We wish we could find an optimistic angle here, but there ain't one.”
“When thinking about a macro-overlay onto a geopolitical framework, one is operating as fast twitch muscle and the other one is going for a marathon" - Roger
This is a reminder that the narratives of de-globalization, re-globalization, nearshoring, and all other iterations of the phrases used to describe the shifting geopolitical backdrop that held together the last 30+ years of global markets, are going to take a very long time to play out. As Roger put it, this is the marathon part. (And all you high strung natural gas traders are the quick twitch muscle.)
Even with Trump's trade war tariffs (which went into effect back in 2018 and are still largely intact under the new administration) and the rising tensions in the South China Sea over the sovereignty of Taiwan, the U.S. trade deficit with China is actually… increasing.
This isn’t to say that at some point the U.S. won’t actually deleverage itself from China, but, it’s important to remember that global trade, mission-critical supply chains, food, and energy security… these themes are incredibly complex and we (myself included) may sometimes get ahead of ourselves in expecting the things we read, no matter how credible the source, to materialize instantaneously in the data. Themes that are tectonic in size and speed mean any meaningful shifts may still be a generation away (at least).
The WSJ did a nice job covering the decimation currently taking place in the U.S. natural gas market (you won’t hear me complimenting mainstream media sources often, so this is a big deal).
Here are a few highlights from the piece (emphasis added throughout):
- “Natural-gas prices have dropped more than 65% since mid-December and this week hit their lowest level since 2020’s pandemic lockdown, leading producers to throttle back drilling in a dramatic turn in the market for the heating and power-generation fuel.
- Producers are trying to avoid swamping the market while traders and analysts are calculating how low prices will need to fall to spur the right mix of curtailments and demand to balance the market.
- In early trading Wednesday, futures dipped below $2, a threshold that has rarely been breached over the past 20 years.
- There hasn’t been much heating demand to draw down supplies this winter. U.S. gas inventories have flipped to an unseasonable surplus after being at a significant deficit to normal levels this past summer, when wholesale prices surged to shale-era highs above $9 per million BTUs.
- The market currently is oversupplied by about 5 billion cubic feet a day and without producers choking back output, U.S. inventories would swell beyond storage capacity before next winter, said Ryan Smith, vice president of consulting at energy-data firm East Daley Analytics. “Prices might still have a little bit of downside risk,” he said.
- The Haynesville lies beneath East Texas and northern Louisiana. Drilling there has boomed since the lockdown to supply liquefied natural gas export terminals and chemical makers along the Gulf Coast. Already, though, big producers in the region are parking drilling rigs.
- Chesapeake Energy said Wednesday that it would drop three of the 14 rigs drilling on its properties this year, starting with one in the Haynesville this quarter. The Oklahoma City company said it expects 2023 production to be less than last year.
- Comstock Resources, a big Haynesville producer controlled by Dallas Cowboys owner Jerry Jones, last week said it was cutting two of the nine rigs it has drilling Haynesville leases, and that the company’s partners in other wells are following suit.
- EQT Corp., the largest U.S. gas producer, said it plans to keep output flat this year.
- Bank of America analysts told clients this week that they believe prices have bottomed and will average $2.45 per million BTUs during the first half of the year before rising in the second half. One risk to their outlook, they wrote, is that producers, flush from last year, might be better able to weather low prices and slow to cut back.
- Demand should climb in the coming weeks as Freeport LNG restarts the Texas export facility that has been down since a June fire. The outage of one of the country’s largest gas export terminals has left a lot of gas in the domestic market that would have been shipped abroad. But big price gains aren’t expected until next year when a batch of new export terminals begin to open, boosting U.S. export capacity by 40%.”
Retail Investor Flows
Just one point to make here: a reminder to index investors that believe they’re getting diversification with their index funds… think again.
It’s somewhat comical to see where retail investors have been putting their money this year after last year’s tech beatdown.
It’s basically tech, and indexes heavily weighted with lots of…. tech.
Let’s get some imagination guys…
Earnings per Share Integrity is Lacking
An interesting trend picked up by Yuri over at Snippet Finance (another one to subscribe to if you haven’t already).
Companies report both GAAP (Generally Accepted Accounting Principles) and non-GAAP (pro forma) earnings as the two metrics can vary, sometimes greatly. While GAAP figures indicate how much money a company made during a reporting period, pro forma earnings tell you how much a company made from its usual, or ordinary business activities in that same period—but with stripped out extraordinary or one-time events, good or bad. Asset write-downs, called impairment charges, and significant one-off P&L losses, like fines, are standard.
2008, a period where just about every company reported a loss, looks like the first large divergence to take place - which makes sense seeing as balance sheets around the world got beat up by the GFC, and large write-offs followed.
But the trend (noticeably higher over time) is what’s interesting, if not a little shocking. What’s causing the rise? Any thoughts? Write to us at firstname.lastname@example.org and give us your two cents.
Zombies Are Now Actually Dying
Since the beginning of the pandemic, the coverage of zombie companies (companies who can barely operate their business while servicing interest payments on their debt, but are unable to actually repay the debt), was widespread, including yours truly.
With zero interest rates and a frothy equity market, these firms were still humming along, but just barely.
But now, with a coordinated global tightening of rates and volatility back in the equity markets (but still subdued), it looks like the zombies are beginning to get laid to rest.
Negative Yielding Debt
Not too long ago, when inflation was still low and interest rates were pinned to zero, negative-yielding debt was a headline story. Most developed countries were actually trying to get inflation and therefore allowed yields on their bonds to float into negative territory.
No longer. Inflation is back and with it comes more aggressive monetary policy – higher rates for (likely) longer, which has zeroed out the number of negative-yielding bonds and averted the ‘crisis’.
A secondary effect, a much more positive one, is that cash is no longer trash, and investors are taking note. Balances in money market funds (de facto cash) have risen substantially alongside these rising rates, which means that investors (and non-investors with a savings account) can, for the first time in a long time, actually earn some yield on their cash, and not be forced far out on the risk curve.
With the fear of ridicule, I actually just purchased, for the first time ever, two 3-month duration CDs yielding 4% - and that’s certainly not trash.
It’s also a good counterbalance to my 95% energy-focused portfolio which is, shall we say, slightly more volatile…
Recommended Reads & Resources
Yes, I actually use these and think you should too...
- Koyfin - we haven't been shy about professing our love for this platform. It's a great alternative to a Bloomberg terminal, at a small fraction of the cost, and I live on it all day. Cannot recommend enough. You'll get 10% off by using this link to sign up (yes, we get a small commission but I'd recommend them for free!).
- The Report - a top-notch, 3x a week newsletter, covering only a few of the most important stories in business, finance, and tech, curated so that you don't spend hours sifting through the headlines.
That's it for February!
As a reminder, on March 6th at 2 PM EST we'll be hosting the Lykeion Research Ask Me Anything with Jacob & Roger on Twitter Spaces. So mark your calendars, follow our Twitter handle to participate, and if you haven't had a chance to read the last report, "Investing Through Japan’s Next Big Inflection Point", now's your chance to catch up.
As always, we'll see you out there...