McTeer is Heard

By: Chad Hudson | Wed, Nov 14, 2001
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I’m not sure how much hand holding there was, but it sure looks like everyone went out and bought a SUV. (Earlier this year Dallas Fed President, Robert McTeer, said "everything would be OK if we'd all just hold hands and buy SUVs".) October retail sales increased at the fastest pace ever recorded by the Commerce Department under the current methodology dating back to 1991. October sales increased 7.1% as zero-percent financing lured everyone to the car lots. Auto sales increased 26.4%. GM has already announced that it will maintain its "Keep American Rolling" sales promotion, although it will be scaled back. The zero-percent financing is already starting to have an affect on used car prices. As consumers buy new cars they are also trading in or selling their older car. Car dealers are reporting a record number of used cars on their lots and are also having trouble moving them at auction. Prestige Ford, here in Dallas, took 50 cars to a wholesale auction and came back with 48. The dealership has 650 used vehicles, compared to 250 normally. The dealership said it plans on devoting more of its promotional budget to used cars when the zero-percent financing ends. Surprise, it looks like it will continue. Manheim Auctions said its index of used-car prices fell at its fastest rate of the year, dropping to 110.4 in October from September’s 112.1. Down the road this could hamper others in purchasing new cars. If trade-ins are worth less, it is probable that consumers are "upside-down" on their existing loan. With credit standards starting to tighten banks will not be very willing to throw the difference into the new loan.

It is highly likely that the strength in October can be partly attributed to consumers bouncing back from the "cocooning" after September 11. Ex-autos, retail sales increased 1.0%, countering much of September’s 1.5% decline. There is little doubt that the record level of mortgage refinancing is another factor that is helping retail sales, especially the Home Depot, Lowes and other housing oriented retailers. The areas that were hardest hit in September, showed the strongest gains in October. Building materials down 2.6% in September, rebounded 2.8% in October. Clothing down 5.9% in September, up 6.9% in October. Restaurants down 2.5% in September, up 1.4% in October.

Unfortunately, these gains can also be attributed to steep discounting and a shift to lower priced stores. Individual retailers paint a different picture. A listing of same-store sales published by Dow Jones shows 39 companies experienced declining same-store sales in October, compared to 23 retailers reporting increases. Most of the gains are coming from the discount retailers such as Wal-Mar, Kohl’s and TJ Max at the expense of department stores and other mall based retailers. Another indication that the increase comes from "catching up" from September, Prudential Securities reported this week that November sales are tracking below plan. Moreover, Prudential sees the upcoming holiday shopping season to be highly promotional. While this will be good for sales, profits will as scarce as Dallas Cowboy first downs.

Another Wall Street analyst published a very candid remark about the retail sector. Donald Trott, retail analyst with Jefferies, has the retail sector in a range of a market weighting to under-weighting. Within his recent third quarter preview Trott writes:

"Although the earnings outlook for the overall retail sector remains dismal for as far ahead as we can see, we look for the strategist community to play the same refrain when the flow of the year end 2002 forecast is unleashed – a mid-year turn in the economy based on increased government spending, a tax-cut and that old chestnut, that interest rate reductions are finally going to kick in. Moreover, the third quarter of 2002 will face very easy comparisons because of the events of 9/11/01. They’ll again declare its time to play early cycle stocks – including retail. While we don’t fully agree with this forecast, it will probably enjoy a moment of general acceptance. It should be emphasized however, that valuations seem pretty stretched."

It is refreshing to see Wall Street start to make fun of their own games.

Earnings warnings continue roll in. According to FirstCall, 362 companies have issued profit warnings for the fourth quarter. This is 15% higher than the 315 warnings given for the third quarter at the same time. This record pace is almost double the 191 issued last year. FirstCall is estimating that earnings will be down about 21.7% for the third quarter, oh yeah those are for the hypothetical earnings. Unadjusted, earnings will be down 72% and S&P’s calculation of operating earnings show profits down 33% from last year.

The capital-spending boom that supposedly led to the increase in productivity, is likely to turn into the reason for dismal corporate profits continuing. As companies spent money on various capital improvements they bloated their fixed expenses to a level that requires sustained growth. Now that the economy is starting to contract, companies are unable to cut costs as fast as sales are slipping. "Companies are still paying for or depreciating the stuff they bought two years ago," said Tom Van Leuven, a J.P. Morgan strategist. The travel industry is one example. While brought about through extraordinary circumstances, it shows how bloated corporate America has become. Merrill Lynch estimates that fixed cost account for 70% - 80% of the airlines’ total cost. All the layoffs in the world will not lead to profitability with this kind of cost structure.

ANC Rental, the parent company of Alamo Rent A Car and National Car Rental, filed for bankruptcy protection yesterday. The amazing aspect of the bankruptcy is how quickly it happened after the attacks. During the second quarter sales were down 6.4% as business travel had already started to slow. Third quarter results have not been released yet, but Michael Egan, CEO of ANC Rental, disclosed car rentals were down 30% following the attacks during an interview on CNBC in late September. Avis Group Holdings, the number two car rental company, said sales are starting to come back, but remain 15% below pre-attack levels. While this arguably is an extreme case, it does show how risky it is to operate with a high level of financial leverage. A multi-billion company was not able to sustain a few bad quarters followed by one very bad one. Unfortunately, corporate balance sheets are more leveraged then they have ever been.

Travel has starting picking back up, but from severely depressed levels. Airline travel is still down 25% from year-ago levels. Now, AAA reports bookings for Thanksgiving air travel are off 27% from last year. Additionally, the number planing to drive to their location increased to 87% from a typical 80%. Boeing is forecasting the slump in air travel will last 28 to 42 months before returning to pre-attack levels.

Wall Street Journal’s Heard on the Street column discussed the effect of pension costs increasing and pulling down corporate earnings. This should not be new news to readers here, but it shows that the accounting tricks of the bull market are starting to get mainstream. Next, Doug Noland will help pen Fannie Mae’s annual report.

Merrill Lynch strategist, Richard Bernstein, is sticking with a defensive strategy for seven reasons. Among the most notable are the excessive valuations still prevalent, saying "…the S&P 500 ratio is now about 44. The market continues to be priced like a growth stock, with little room left for disappointment." Relative valuations are indicating investors are paying for risk. Higher quality stocks are cheaper than lower quality stocks based on 2002 earnings in all ten sectors. Profits continue to deteriorate without any relief in the near future. Bernstein thinks the technology sector still need to consolidate. There are simply too many companies competing and margins will continue to suffer.

He also sees credit deterioration being a problem. He thinks the current "0% financing for consumers may be the peak event of the consumer credit cycle." Additionally, "we view the company [Providian] as being the "canary in the mine shaft." The canary appears to be in trouble, yet other consumer financing companies seem to be breathing deeply in the mine shaft."


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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