You had me at chicken abnormalities and woody breast meat

You had me at chicken abnormalities and woody breast meat

Examining revenue growth at chicken-producing companies such as Tyson Foods and Sanderson Farms shows a surge in chicken consumption over the last several years. Some of this has to do with the consumer shift to healthier eating and alternative low-carb lifestyles that focus on protein consumption as well as rising demand associated with our New Global Middle-class investing theme. In a bid to meet demand, chicken producers have sought solutions to grow more birds and make them bigger to render more meat, but there have been abnormalities about these fast-growing birds that are prompting questions. When we hear abnormalities and problems when it comes to the food we eat, we see it as a prompt for consumers to knowingly look for foods that are in line with our Cleaner Living investment theme.  We are after all what we eat.

Chicken companies spent decades breeding birds to grow rapidly and develop large breast muscles. Now the industry is spending hundreds of millions of dollars to deal with the consequences ranging from squishy fillets known as “spaghetti meat,” because they pull apart easily, to leathery ones known as “woody breast.”

The abnormalities pose no food safety risk, researchers and industry officials say. They are suspected side effects of genetic selection that now allows meat companies to raise a 6.3-pound bird in 47 days, roughly twice as fast as 50 years ago, according to the National Chicken Council.

Researchers and breeders are still trying to pin down the exact cause of problems, a Tyson spokesman said. “While there are some factors linked to the occurrence—including bird weight, feed ingredients and the time of year the bird is grown—even a combination of these factors will not necessarily produce the same issues consistently,” he said.

That efficiency drive has helped U.S. meat giants such as Tyson Foods., Pilgrim’s Pride Corp, Perdue Farms Inc. and Sanderson Farms Inc. produce a record 42 billion pounds of chicken nuggets, tenders and other products in 2018. Now, it’s adding an estimated $200 million or more in annual industry expenses to identify and divert breast fillets that are too tough, too squishy or too striped with bands of white tissue to sell in restaurants or grocery stores, according to researchers at the University of Arkansas.

“There is proof that these abnormalities are associated with fast-growing birds,” said Dr. Massimiliano Petracci, a professor at the University of Bologna in Italy, who leads a team of researchers investigating the chicken breast problems in breeds used in commercial farms.

 

Source: Fast-Growth Chickens Produce New Industry Woe: ‘Spaghetti Meat’ – WSJ

Tyson Foods eyes China and our New Global Middle-class investing theme

Tyson Foods eyes China and our New Global Middle-class investing theme

Noel White, the new CEO of beef, chicken and pork company Tyson Foods, is looking to capitalize on our New Global Middle-class investing theme as it considers overhauling its strategy in China. One of the key tenants in our Rise of the New Middle-class theme is the trade up in products, services, and other purchases, including food, that consumers will make as their disposable incomes rise. From Tyson’s perspective, tapping into this tailwind should drive revenue and profits on the back of rising protein demand in China and other emerging economies.

Tyson Foods Inc. is looking to expand internationally to help stabilize its business and reduce exposure to U.S. agricultural-market swings, its chief executive said.

The Arkansas-based company is considering acquisitions in new markets and revamping its strategy in China, where earlier investments in company-run poultry-farming complexes have struggled, said Noel White, who took over as Tyson’s chief executive officer at the end of September.

Tyson’s effort to rebuild its overseas presence is a way for the top U.S. meat company by sales to harness growing protein demand in developing countries as well as in established markets for meat, Mr. White said in his first interview since taking over.

A broader international presence would make Tyson less reliant on the ups and downs of the U.S. meat sector, where processors like Tyson, Pilgrim’s Pride Corp. and Hormel FoodsCorp. are grappling with low prices and growing meat supplies.

Source: Tyson Foods CEO Looks to Make International Acquisitions – WSJ

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

TRADE ALERT: Freight pain leads to this Economic Acceleration/Deceleration addition

 

KEY POINTS FROM THIS ALERT:

  • We are issuing a Buy on truck company Paccar (PCAR) with an $85 price target as part of our Economic Acceleration/Deceleration investment theme.

With the market’s volatility over the last several days, a number of stocks are revisiting levels that are 5%, 10%, 15% lower than they stood at end of January. And while investors have been thunderstruck by the market gyrations, the day to day data from the December quarter earnings season as well as recent economic data, has continued to confirm certain opportunities. One of the recurring drum beats this earnings season has been companies ranging from Tyson Foods (TSN, Hershey (HSY), Packaging Corp. of America (PKG), Sysco (SYY) and J.M. Smucker (SJM) to Tractor Supply (TSCO) and Prestige Brands (PBH) talking about rising freight costs and the impact on earnings.

One of the culprits is the national shortage in available trucks, which has sent shipping costs soaring, with retailers and manufacturers in some cases paying over 30% above typical rates to book last-minute transportation for cargo. This, of course, goes hand in hand with the accelerating shift toward digital commerce that we talk about, a shift that led Amazon to correctly assess back in 2013 that as more shoppers bought products online, “parcel volume was growing too rapidly for existing carriers to handle.” As that shift to digital commerce has happened, we’ve seen that forward-looking view come to play out, and odds are it’s only going to get worse. According to Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 3Q 2017, but we see that only growing further. In South Korea, e-commerce represented 18% of all retail sales in 2016 with forecasts calling for that percentage to reach 31% by 2021. We may not reach such a level for years to come, but each percentage point that e-commerce gains, means more product that needs to be shipped from a warehouse to the buyer.

Historically, the trucking industry has been associated with the economic cycle. When the economy is growing, more goods (parts, subassemblies, products) need to be shipped to customers at factories, distribution sites, warehouses and so on. According to the American Trucking Association, the trucking industry accounts for 70.6% of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods. This has made freight traffic a good barometer of the economy, and the December year over year increase of 7.2% in the Cass Shipments Index capped off a year in which the ATA’s truck tonnage index rose 3.7%, the strongest annual gain since 2013.

 


As truck tonnage climbed in late 2016 and 2017, industry capacity has been tightening after tepid tonnage in most of 2015 and the first half of 2016 leading to the robust jump in freight costs we described above. This data point from DAT Solutions puts in all into perspective – “there were about 10 loads waiting to be moved for every available truck in the week ending Jan. 20, compared with three in the same week last year…”

 

As freight costs climbed in the back half of 2017, so too did heavy truck orders, which have continued to climb into 2018. According to ACT Research, December 2017, which saw a 76% increase in truck order volume was the best month for orders since December 2014. In full, due to the year-end surge, 2017 saw truck orders hit 290,000 units, up 60% year over year. That strength continued into January with monthly truck orders hitting some 47,000 units, the highest level since 2006.

 

 

This data is not surprising, given that for the first three weeks of January, national average spot truckload rates were higher than during the peak season in 2017, according to DAT. January was also the fourth consecutive month in which truck orders were above the 30,000 mark. Initial heavy truck forecasts put orders near 300,000 for 2018, however tight industry capacity combined with companies that are benefitting from tax reform and looking to replace older, less fuel-efficient trucks, we could see that some lift to that forecast in the coming months.

But that’s heavy truck orders, and while four months above 30,000 paves the way for a pick-up in business, the real question to focus on is heavy truck retail sales. Heavy truck, otherwise known in the industry as class 8 trucks, industry retail sales were 218,000 units in 2017, compared to 216,000 vehicles sold in 2016, with forecasts calling for 235,000-265,000 trucks to be sold in the U.S. and Canada during 2018.

Looking outside the U.S. and Canada, the data shows an improving European economy and that should give way to a favorable truck market there as well. European truck industry sales above 16-tonnes were a robust 306,000 trucks in 2017, and It is estimated that European truck industry sales in that category will be in the range of 290,000 to 320,000 trucks in 2018.

 

Paccar – more than a leading heavy truck company

And that brings us to Paccar (PCAR), whose shares have fallen some 15% as the domestic stock market moved sharply lower over the last two weeks. The company is an assembler of heavy-duty trucks, with an estimated market share near 31% in the U.S. and Canada, as well as medium duty trucks (think the kind you see being driven locally by United Parcel Services (UPS) and FedEx (FDX)). That business drove 53% of its truck deliveries in 2017, with the balance coming from Europe (36%) and other markets (11%). As truck retail sales improve in the U.S., Canada and Europe, even absent additional share gains, Paccar’s truck business in terms of revenues and profits should see a nice lift.

The improving truck market also bodes well for Paccar’s high margin truck financing business – while it generated just 6.5% of total revenue in 2017 with operating margins that are more than double the truck business, it accounted for 12% of overall operating profits.

The third leg to the Paccar stool is its Parts business (20% of 2017 revenue, 28% of 2017 operating profit), which stands to benefit from the time lag between truck orders and sales in a capacity constrained industry, where up-time for existing equipment will be crucial.

Given the industry dynamics and Paccar’s position, we are seeing revenue and earnings expectations move higher in recent weeks, with the current consensus calling for EPS of $5.34 this year up from $4.26 in 2017 on a 13% revenue increase to $20.6 billion. With the company only recently sharing its 2018 tax rate will be 23%-25% vs. 31% in 2017, we could see the 2018 consensus move higher in the coming weeks.

As mentioned above, Paccar’s share price has fallen some 15% in the last two weeks, which in our view makes the shares rather compelling given our $85 price target. That target equates to just under 16x 2018 EPS. Over the prior seven years, PCAR shares have bottomed at an average P/E of 12.2x, which derives a downside target of $67.65 based on current 2018 EPS expectations. On the upside, the average peak multiple over those same years of just over 17x hints at a potential price target near $95. Looking at a dividend yield valuation, we see upside vs. downside of $82 vs. $60.

As we add the shares, we’ll split the difference with an $85 price target, and we’ll look to aggressively scale into the shares should the market come under further pressure and drag PCAR shares closer to $60. In terms of sign posts to watch for the shares in the coming days and weeks, monthly heavy truck data as well as tonnage stats and manufacturing industrial production data is what we’ll be watching. As the current earnings season winds on, we’ll be focusing on the results and outlook from Rush Enterprises (RUSHA), which owns the largest network of commercial dealerships in the U.S., with more than 100 dealerships in 21 states.

 

The bottom line for this alert today:

  • On Monday morning we are adding Paccar (PCAR) shares to the Tematica Investing Select List.
  • Our price target for PCAR shares is $85, nearly 26% above where the shares closed on Friday February 9.
  • At this time we are not setting a protective stop loss, but instead will look to scale further into the shares should further pressure drag them closer to $60 per share. 

 

Why the On-Demand Economy Doesn’t Make the Thematic Cut

Why the On-Demand Economy Doesn’t Make the Thematic Cut

We keep hearing that thematic investing is gaining significant popularity in investing circles, especially when it comes to Exchange Traded Funds (ETFs). For more than a decade, we’ve viewed the markets and economy through a thematic lens and have developed more than a dozen of our own investing themes that focus on several evolving landscapes. As such, we have some thoughts on this that build on chapters 4-8 in our book Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals for Better Returns

One of the dangers that we’ve seen others make when attempting to look at the world thematically as we do, is that they often confuse a trend — or a “flash in the pan”  — for a sustainable shift that forces companies to respond. Examples include ETFs that invest solely in smartphones, social media or battery technologies. Aside from the question of whether there are enough companies poised to benefit from the thematic tailwind to power an ETF or other bundled security around the trend, the reality is that those are outcomes — smartphones, drones and battery technologies — are beneficiaries of the thematic shift, not the shift itself.

At Tematica Research, we have talked with several firms that are interested in incorporating Environmental, Social and Governance — or ESG — factors as part of their investment strategy. Some even have expressed the interest in developing an ETF based entirely on an ESG strategy alone. We see the merits of such an endeavor from a marketing aspect and can certainly understand the desire among socially conscious investors to ferret out companies that have adopted that strategy. But in our view and ESG strategy hacks a sustainable differentiator given that more and more companies are complying. In other words, if everyone is doing it, it’s not a differentiating theme that generates a competitive advantage that will provide investors with a significant beta from the market.

But there is a larger issue. A company’s compliance with an ESG movement is not likely to alter the long-term demand dynamics of an industry or company, even if certain businesses enjoy a short-term surge in revenues or increased investor interest based on a sense of goodwill.

For example, does the fact that Alphabet (GOOGL) targets using 100 percent renewable energy by 2018 alter the playing field or improve the competitive advantage of its core search and advertising business? Does it do either of those for YouTube?

No and no.

At the risk of offending those sensitive about their fitness acumen, it makes as much sense as investing in an ETF that only invests in companies with CEOs who wear fitness trackers. Make no mistake, our own Tematica Research Chief Macro Strategist Lenore Hawkins, a fitness tracker aficionado herself, would love to see more fitness trackers across the corporate landscape, but an ETF based on such a strategy means investing in companies across different industries with no cohesive tailwind powering their businesses, likely facing very different market forces that overshadow the impact of the one thing they have in common. To us, that misses one of the key tenants of thematic investing.

The result is a trend that is likely to be medium-lived, if not short lived. Said another way, it looks to us to be more like an investing fad, rather than a pronounced thematic driven shift that has legs.

Subscribers to our Tematica Investing newsletter know we are constantly turning over data points, looking for confirmation for our thematic lens, as well as early warning flags that a tailwind might be fading or worse, turning into a headwind. As we collect those data points, we mine the observations that bubble up to our frontal lobes and at times, ask if perhaps we have a new investing theme on our hands. Sometimes the answer is yes, but more often than not, the answer comes up “no”.

Now you’re in for a treat! Some behind the scenes action if you will on how we think about new themes and why one may not make the cut…

 

The On-Demand Economy:  Enough to become a new investing theme?

 Recently we received a question from a newsletter subscriber asking if the number of “on-demand” services and business emerging were enough to substantiate the addition of a new investment theme to go along with the other 17 themes we currently track.

By on-demand, we’re talking about those services where you can rent a car, (Lyft or Uber) or find private lodging (AirBnB) with the click of a button for only the time you need it rather than rent an apartment or studio for a week or month. It also refers to the many services that will deliver all the ingredients you need to prepare a gourmet meal in your own kitchen, such as the popular service Blue Apron or HelloFresh.

It was an interesting question because we have been debating this at Tematica Research for quite some time. We’re more than fans of On Demand music and streaming video services like those offered by Amazon (AMZN), Netflix (NFLX), Pandora (P), Spotify and Apple (AAPL).  Ultimately, we came to the conclusion that the real driver behind the on-demand economy is businesses stepping into fill the void created by a combination of multiple themes, rather than a new theme in of itself. Here’s what we mean . . .

Take the meal kit delivery services like Blue Apron, what’s driving the popularity of this service? We would argue that it’s not the fact that people like seeing their UPS driver more. Rather it is the result of underlying movement towards more healthy and natural foods that omit chemicals and preservatives — something we have discussed as the driver behind our Foods with Integrity theme — on top of a bigger Asset Light investment theme in which consumers and businesses outsource services, rather than accumulating assets and then performing the service themselves. The on-demand component of Blue Apron is not driving the theme, but is a beneficiary of what we call the thematic tailwind.

The challenge with the shift towards healthier cooking, that sits within our Foods with Integrity thematic, is the amount of work, and in many cases equipment, it takes to cook such foods — the shopping, the measuring, the cutting, special cooking utensils and preparation time, not to mention the cost. Recognizing this pain point, Blue Apron saw opportunity and consumers have flocked to it. As we see it, the meal delivery services are an enabler that addresses a pain point associated with our Foods with Integrity theme, rather than an independent theme unto itself.

There is also a clear element of the Connected Society investment theme behind these services, given how customers order the ingredients to prepare the meals – via an app or online – as well as our Cashless Consumption theme, given the method of payment does not involve cash or check and Asset Light whereby consumers pay for the end product, rather than investing in assets so that they can make it themselves. So that we are clear, the primary theme at play here is Foods with Integrity, but we love to see the added oomph when more than one theme is involved.

 

 Let’s look at Uber, the on-demand private taxi service. 

We’re big users of the service, particularly when traveling, and we love the ease of use. To us, while the service offered by Uber is very much On-Demand, from the customer perspective, it fits into our Asset Light theme, as it removes the need to own a car. If you think about, what’s?  the amount of time you spend using your car compared to the amount of time it spends parked at home, at work or in a parking lot? The monthly cost to own and maintain that vehicle vs. the actual number of hours it is used offers a convincing argument to embrace an Asset Light alternative like Uber.

We also like the payment experience — or the lack of an experience. We’re talking about having the ride fee automatically charged. No cash, no credit card swiping or inserting, no awkward “how much do I tip?” moments. It’s our Cashless Consumption theme in all of its glory, walking hand-in-hand with Asset Light — and the only thing better than a strong thematic tailwind behind a company is two!

The biggest users of the Uber and Lyft services, and the ones driving the firms’ valuations to stratospheric levels, are the Millennials who are opting to just “Uber “ around town — it’s become a verb — or use a car-sharing service like a ZipCar (ZIP) or the like.

Sure, Millennials have the reputation of being a more thrifty, frugal group compared to previous generations. But we have to wonder is it them being thrifty or just coming to grips with reality?

With crushing costs of college and student loans, as well as stagnant wage growth, many young workers are forced to cobble together part-time and contractor jobs rather than enjoying a full-time salaried position, so what choice do they have? Why buy a car and pay for it to sit there 95% of the time when you can just pay for it when you need it?

We call that the Cash-strapped Consumer theme meets Asset Light, and many businesses have also stepped in to service this rising demand for what has become known as the “sharing economy.”

 

Finally, what is the underlying function of all these on-demand services?

As we mentioned earlier, it’s the ability to connect and customize the services that consumers want through a smartphone app or desktop website, or from our thematic perspective, the Connected Society.

One of the key words in the previous sentence was “service.” According to data published by the Bureau of Economic Analysis in December 2015 and the World Bank, the service sector accounted for 78 percent of U.S. private-sector GDP in 2014 and service sector jobs made up more than 76 percent of U.S. private-sector employment in 2014 up from 72.7% in 2004. Since then, we’ve seen several thematic tailwinds ranging from Connected Society and Cash-strapped Consumer to Asset Light and Disruptive Technologies to Foods with Integrity that either on their own, or in combination, have fostered the growth of the US service sector. Given the strength of those tailwinds, we see the services sector driving a greater portion of the US economy. What this means is folks that have relied heavily on the US manufacturing economy to power their investing playbook might want to broaden that approach.

Now let’s tackle the thematic headwinds here

Headwinds involve those companies that are not able to capitalize on the thematic tailwind. A great example is how Dollar Shave Club beat Gillette, owned by Proctor & Gamble (PG), and Schick, owned by Edgewell Personal Care (EPC), by addressing the pain point of the ever-increasing cost of razor blades with online shopping. Boom — Cash-strapped Consumer meets Connected Society.

While Gillette has flirted with its own online shave club, the price of its razor are still significantly higher, and as far as we’ve been able to tell, Schick has no such offering. As Dollar Shave Club grew and expanded its product set past razors to other personal care products, Unilever (UL) stepped in and snapped it up for $1 billion.

Going back to the beginning and the impact of the food delivery services like Blue Apron — are we likely to see food companies build their own online shopping network? Most likely not, but they are likely to partner with online grocery ordering from Kroger (KR) and other such food retailers. That still doesn’t address the shift toward healthy, prepared meals and it’s requiring a major rethink among Tyson Foods (TF), Campbell Soup (CPB), The Hershey Company (HSY), General Mills (GIS) and many others. Fortunately, we’ve seen some of these companies take actions, such as Hershey buying Krave Pure Foods and Danone SA (DANOY) acquiring WhiteWave Foods, to better position themselves within the thematic slipstream.

The key takeaway from all of this is that a thematic tailwind can be thought of as a market shift that shapes and impacts consumer behavior, forcing companies to make fundamental changes to their business model to succeed. If they don’t, or for some reason can’t, odds are their business will suffer as they fly straight into an oncoming headwind.

Recall how long Kodak was the gold standard for family photographs, yet today it is nowhere to be seen, killed by forces that emerged completely from outside its industry. As digital cameras became ubiquitous with the advent of the smartphone and the cost of data transmission and storage continually fell, the capture and sharing of images was revolutionized. Kodak didn’t keep up, thinking that film would forever be the preferred medium, and paid the ultimate price.

As thematic investors, we want to own those companies with a thematic tailwind at their back — or maybe even two or three! — and avoid those that either seem oblivious to the headwind or won’t be able to reposition themselves, like a hiker who finds he or she has already gone way too far down the wrong path and is so utterly lost, needs to be helicoptered to safety.

Of course, when it comes to these “On-Demand Economy” darlings — Uber, Dollar Shave Club, Airbnb —few if any of them are publicly traded, which frustrates us so, since most of them are tapping into more than one thematic tailwind at once. If and when they do turn to the public markets for some added capital and we get a look into the economics of these business models, then we’ll also get to see the key performance metrics and financials behind these businesses.

In the meantime, stay tuned as we will be discussing more readily investable thematics next.