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US Economy

A Moving Story

By Elliott H. Gue, on Jan. 31, 2014

The stock market tends to track economic conditions over the long term. However, any experienced investor will tell you that this link isn’t always clear and that being right about the economy doesn’t automatically translate into success in the stock market.

Case in Point: Despite lackluster US economic growth, the S&P 500 soared more than 56 percent from 2010 to 2013.

Although investors should monitor key macroeconomic indicators such as employment data and the Purchasing Managers Index, these data series are hardly the last word on investing. The US Bureau of Labor Statistics, for example, routinely (and sometimes dramatically) revises its initial estimates in subsequent months; placing too much emphasis on any single economic data point can lead to faulty forecasts and decision-making.   

Investors buy stocks, not the economy. And when you purchasing a stock, you’re buying a stake in a business–not the economies in which that business operates.

That’s not to suggest that the health of the economy and business conditions aren’t related; rather, investors should supplement their analysis of economic data by keeping abreast of what corporate managers have to say about these matters.

US companies report earnings every four months, and many host conference calls with analysts to discuss their results and business trends. These comments can tell you far more about the economy and conditions on the ground than any single economic data series.

I can tell you from experience that company-level requires more time to collect and analyze. You can’t expect to get ahead by read a company’s quarterly press release or comparing earnings to Wall Street’s consensus estimates; the best nuggets of insight often occur during management’s conference calls with analysts or in a company’s 10-Q and 10-K filing.

Getting a read on economic conditions and the business outlook for various sectors and industries requires listening to a seemingly unending stream of conference calls. 

At Capitalist Times, we spend hours poring over companies’ filings and listening to earnings calls. These times of the year involve a great deal of work, but these efforts can be well-rewarded if you uncover a profitable opportunity. 

Here’s a look at insight gleaned from recent earnings class hosted by three transportation companies.

Ship Shape: Carnival Corp (NYSE: CCL)

The world’s leading operator of cruise ships, Carnival Corp boasts a fleet of about 100 vessels and controls about 45 percent of the market. Nevertheless, the company has endured choppy waters over the past two years because of a series of high-profile incidents at sea.

In January 2012, the Costa Concordia ran aground off the coast of Italy because of an error by its captain.

And last year, the Carnival Triumph experienced an engine fire that caused a ship-wide power failure and knocked out all running water and sewage systems on the ship.

A few weeks later, the Carnival Legend limped back to Tampa after a serious malfunction in the propulsion system necessitated skipping a planned stop in the Cayman Islands.

A string of high-profile mishaps sullied the cruise line’s reputation and weighed on bookings.

Regardless of Carnival’s recent travails, cruises are a classic form of discretionary spending; demand for these vacations provides useful insight into the health of the economy and consumer spending.

Check out these telling comments from CFO David Bernstein during a conference call to discuss Carnival’s results for the fourth quarter ended Nov. 30, 2013:

For the first half of 2014, fleet-wide volumes during the last 13 weeks have been running well ahead of the prior year, outpacing capacity at prices that are lower. Despite the recent high volumes, the cumulative bookings for the first half on a fleet-wide basis are still behind at lower prices. As a result of the booking trends, we are expecting lower yields in the first half. Our North American brands are impacted by challenging comps from the first half of last year, as they were booked prior to the voyage disruptions that occurred in February.

Our EAA brands face ongoing economic environment challenges in Southern Europe, the loss of the attractive Red Sea program and a close-in booking curve that is impacting their first half.

In this passage, Bernstein attributes some of the year-over-year increase in bookings to lower fares, as opposed to strengthening demand. The CFO also notes that cumulative bookings for the first half of 2014 have fallen below year-ago levels, despite discounted prices.

These struggles reflect challenging comparisons that preceded the high-profile incidents that occurred during last year’s Caribbean cruise season, though demand in Europe and Asia has also weakened. Apparently, the EU economy’s gradual recovery has yet to filter through to the cruise market.

That being said, the momentum in Carnival’s bookings over the trailing 13 weeks suggests that the acceleration in US economic growth toward the end of 2013 may have started to show up in the form of higher discretionary spending.

Bernstein’s comments on demand for the firm’s Alaskan and European cruises also paint an encouraging picture of consumer spending.

Alaska is behind on price but well ahead on occupancy. Recent booking volumes have been solid which bodes well for pricing on the remaining inventory. The seasonal European program for our North American brands is showing signs of strength, particularly in the peak summer season, which falls into our third quarter where we are up nicely in both price and occupancy.

The CFO notes that although price cuts helped to drive demand for Alaskan cruises, the company appears ready to hike prices on its remaining inventory of cabins. And North Americans’ appetite for travel in Europe also appears robust–a sign that the US economy continues to improve.

CEO Arnold Donald emphasized that a strengthening US economy has even helped Carnival’s business to recover more rapidly than expected from the now-infamous poop cruise that took place in February 2013:

With regards to Carnival, we’ve experienced some accelerated recovery in Carnival, experiencing that especially here in the fourth quarter, in the fourth quarter just closed.

But we are cautious, looking forward, to make certain we have a clear view after the wave season, given the added capacity that has gone into the Caribbean. But at this point, certainly, the Carnival recovery is a little bit ahead of that two to three-year timeframe that is conventional kind of thinking concerning recovery of brands that have suffered incidents.

If strengthening consumer spending can help Carnival put the “poop cruise” in its wake, US economic growth must be accelerating.

Friendly Skies: Delta Air Lines (NYSE: DAL)

For 25 years, the shares of US airline stocks have been unfriendly skies for investors. For example, the major US air carriers in 2002 lost more money than they made in cumulative profits since 1978.

But the major carriers have finally taken the necessary steps toward profitability, eliminating unprofitable routes and retiring older airplanes.

And when AMR Corp (the parent of American Airlines) merged with US Airways in December 2014, the number of legacy US air carriers dropped to three from six in 2008. This wave of consolidation helped to alleviate the cutthroat fare wars that had plagued the airline industry since deregulation.

Delta Air Lines’ bullish results and earnings call justified our optimistic outlook for our favorite US airline stocks.

The air carrier’s total passenger revenues per available seat mile (PRASM) increased by 3 from year-ago levels, driven by a 6.6 percent increase in domestic sales and a 7.9 percent uptick in average revenue per mile flown by paying passengers. These strong results reflect Delta Air Lines’ significant pricing power in a more rationale competitive environment.

Within the domestic market, New York City stood out, posting an 8 percent jump in PRASM and a 10 percent increase in average revenue per mile flown by paying passengers. LaGuardia Airport led the way, with PRASM growth of 15 percent.

Delta Air Lines’ management team highlighted these trends in the firm’s fourth-quarter earnings call:

Analyst: I think Ed, when you were going through your commentary, you talked about particularly – you saw particularly the strength in the New York markets. What’s behind this? And maybe this is for Glen as well. I mean, was this the startup of the Virgin business? Is this the growth in corporate share? Is this LaGuardia really starting to mature now? What drove that?

Edward H. Bastian, President: Well, I think you answered your own question. It’s all of the above, right. We’ve been investing in New York for the last five years and we’re really starting to see the fruits come through. I’d say one of the largest contributors was clearly the corporate market share improvements that we’re seeing, particularly in the banking sectors.

Delta Air Lines has modernized and improved its operations in New York City–investments that have enabled the carrier to win market share from competitors.

But a general improvement in demand for corporate and business travel at this hub signals that the US economy continues to pick up steam.

Management also cited a recent survey of corporate travelers in which 90 percent of respondents said they planned to maintain or increase their airfare expenditures, suggesting that the airlines should be able to push through addition price increases. These tailwinds should continue to lift North American profit margins for the best-positioned carriers.

Delta Air Lines’ international segment posted mixed results in the fourth quarter, with revenue on Latin American routes ticking up 2 percent and sales in the trans-Pacific market increased by 2 percent.

Management provided additional color on these trends during the Q-and-A portion of the company’s fourth-quarter earnings call:

Analyst: Can you just give us a sense of what you anticipate industry capacity for trans-Atlantic and trans-Pacific during the course of the year and how you’re seeing the pricing environment on those two routes?

Edward H. Bastian: Sure. In Europe, we see a little bit more capacity than we like and we think capacity will probably exceed GDP rates between the Eurozone and US.

Having said that, that capacity – pieces of that are already in place now, so if you look at the capacity that’s in the winter schedules, it’s running a little bit further ahead than it had in the last few quarters. And it’s already ahead of GDP forecast for the fourth quarter for Europe and the US.

And under that environment, we’ve been able to continue to grow unit revenue. So, we’re pretty satisfied with the results we’re seeing come out of the low season in Europe. And hopefully, as we get to the high season, those trends will continue.

In the case of the Pacific, we see a better capacity balance in terms of what the industry is offering, particularly in Japan, and as you know, Japan accounts for about 35 percent of our – or Trans-Pacific Japan part of our network accounts for about 35 to 40 percent of our total Trans-Pacific.

In that case, for the first time in three years we actually see capacity being offered by the industry down into the peak summer months combined with the fact that the yen should stabilize, or we believe is stabilizing here at about 100 to 105. That should provide some very good tailwinds as we head to the summer in Japan.

Management stated that capacity additions in the trans-Atlantic market have exceeded outpaced growth in Europe, though Delta Air Lines still managed to grow its revenue slightly during the quarter. This resilience bodes well for the summer travel season.

But Delta Air Lines’ hefty exposure to Japan stung the company last year, as the value of the yen declined significantly. Management expects the US dollar-Japanese yen exchange rate to stabilize on 2014, while flight capacity in the region should shrink heading into the peak summertime travel months.

The biggest takeaway from Delta Air Lines’ earnings: Strong demand for travel in the US should drive revenue and margin expansion in the coming year.

We’ll highlight our favorite play on this trend in this week’s issue of Capitalist Times Premium; if you’re not already a subscriber, sign up today to make sure you don’t miss out on this opportunity.

Riding the Rails: CSX Corp (NYSE: CSX)

CSX Corp’s stock sold off after the company reported fourth-quarter earnings that fell short of analysts’ consensus estimate by $0.01 per share–a classic example of investors’ looking for an excuse to take profits.

The rail operator’s solid underlying results were undone by a temporary surge in costs. In a conference call to discuss fourth-quarter earnings, CEO Michael Ward highlighted these strengths:

Revenue grew 5 percent in the quarter where the ongoing headwinds in coal were more than offset by broad-based growth in our merchandise and intermodal markets, reflecting an economy that is expanding. In addition, operations were resilient, even with the volume increase and the challenging winter weather at the end of the quarter, as we activated additional resources to keep the network fluid and service levels high.

CSX’s definition of merchandise comprises three broad product categories: agricultural, industrial and housing and construction. An uptick in transportation volumes of automobiles, chemicals, wood products and other merchandise usually reflects accelerating economic growth, while rising intermodal shipments imply rising demand for consumer and industrial goods.

Strong intermodal volumes also bode well for freight trucking outfits; we covered our favorite name in this industry in the Dec. 31, 2013, issue of Capitalist Times Premium. (See The Small-Cap Wonder that Keeps on Trucking.)

The coal market, in contrast, has experienced serious headwinds in recent years, as depressed natural-gas prices and the no-show winter of 2011-12 weighed heavily on demand and bloated US utilities’ inventories of thermal coal.

Meanwhile, slowing economic growth in emerging markets has crimped global demand and pricing for metallurgical coal exported from the US. And the recession in Europe has lowered demand for exports of thermal coat from the East Coast..

But the recent surge in natural-gas prices will drive gas-to-coal fuel switching at power plants that have the flexibility to burn both thermal fuels. Although coal inventories in the South remain elevated, stockpiles in the Northeast have returned to normal levels.

And growth in other product categories should more than offset persistent weakness in CSX’s coal volumes. Clarence Gooden, CSX’s chief commercial officer, touched on these areas of strength during the company’s fourth-quarter earnings call:

Looking forward, we expect stable to favorable conditions for over 90% of our markets and the overall volume outlook for the first quarter is positive. Looking at some of the key markets, agriculture is favorable with higher year-over-year crop yields supporting continued growth in grain shipments.

The outlook for the automotive market is also favorable as North American light vehicle production continues to grow. We expect growth in chemicals as we continue to capture opportunities created by the expanding domestic oil and gas industry.

We expect our domestic coal volume will grow in the first quarter as we cycle a relatively weak first quarter in 2013. At the same time, our outlook for full-year domestic coal volume is neutral. But the average length of haul will be shorter this year and will contribute to a lower, overall revenue per unit.

The continued expansion in the U.S. housing and construction markets will drive growth in forest products and in our mineral markets. Strong intermodal growth will continue as our strategic network investments and service reliability support highway-to-rail conversions. The outlook for our phosphate and fertilizer volumes is neutral due to high inventory levels and volatile commodity pricing, which produces uncertainty in the market.

Our Wealth Builders Portfolio includes several names that stand to benefit from recovering demand for automobiles, car parts, and housing-related projects; these stocks have been among our most profitable positions since Capitalist Times Premium launched in June 2013.

CSX’s bullish outlook for shipment volumes in these product categories suggests there’s more upside to come for these stocks.

And the upsurge in rail shipments of crude oil and petrochemical products reflects the nation’s push toward energy independence.

The boom in domestic crude-oil production means that the US no longer imports significant quantities of light-sweet crude oil to the Gulf Coast, while rail shipments of crude oil to refineries on the East Coast continue to displace expensive imports.

Meanwhile, oil and gas companies’ overzealous production of natural gas and natural gas liquids has restored the fortunes of domestic chemical producers, an energy-intensive industry that relies on these commodities to generate power and as feedstock. Within this space, olefin producers have benefited the most from trends in the energy patch.

The two most prominent olefins, ethylene and propylene, serve as the basic building blocks for three-quarters of all chemicals, plastics and synthetic fibers. Petrochemical firms produce these commodity chemicals in cracking facilities, the majority of which are located on the Gulf Coast, that heat ethane and propane with steam.

Whereas ethane and propane account for about 90 percent of the feedstock used at cracking facilities in the US, petrochemical plants in Western Europe generate more than 70 percent of their ethylene from naphtha and other petroleum derivatives that hinge on the price of Brent crude oil. Plants in Asia likewise rely heavily on naphtha as a feedstock.

Eager to exploit this cost advantage, petrochemical companies have run their US capacity around the clock and announced a number of major projects to build world-scale crackers or expand existing facilities. This boom has led to an upsurge in chemical volumes on the nation’s railways.

The biggest negative from CSX’s fourth quarter: A spike in labor-related costs that management expects to dissipate in the coming year.

The Verdict

Comments from Carnival, Delta Air Lines and CSX suggest that US economic growth has accelerated after years of a not-so-great recovery. Our outlook calls for US gross domestic product to increase by about 3 percent in 2014, which suggests that the S&P 500 should deliver solid returns in 2014.

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Recent Media Appearances

01/06/14: BNN — Roger Conrad, Top Canadian Energy Stock Picks
01/10/14: Marketwatch — Roger Conrad, What to Buy Instead of Bonds
01/14/14: Wall Street for Main Street — Roger Conrad, Dividend Investing in 2014

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