Feb 22, 2019

Buffett, 3G Capital Absorb Billions in Body Blows: Taking Stock

Brad Olesen, Bloomberg News

Kraft Heinz Co. Kraft brand thousand island salad dressing is arranged for a photograph in Tiskilwa, Illinois, U.S., on Wednesday, Aug. 2, 2017. Kraft Heinz is scheduled to release earnings figures on August 3. Photographer: Daniel Acker/Bloomberg , Bloomberg

(Bloomberg) -- Before we can get to any of the overnight action, or discuss how mid-cap Stamps.com lost half its value in a matter of minutes (after losing USPS as a partner), we have to talk about the elephant in the room, Kraft, and how the just over 3-year old merged entity is poised to open at a record low (the Street is piling on, with 4 downgrades as of this writing) after disclosing an SEC subpoena, writedowns amounting to $15.4 billion and weaker than expected financial results.

The irony in discussing said elephant is that just this week the WSJ had an item out discussing how Warren Buffett, his Berkshire Hathaway (and that elephant gun) were finding it difficult to locate great deals in which to invest. Given that Berkshire teamed with 3G to originally form this condiment powerhouse (and collectively controlling the company with hundreds of millions of shares), it seems, at face value at least, even the deals that were found hadn’t turned out all that great.

Though the issues are company specific, there’s no doubt that with market value losses exceeding the entire size of packaged food peer Campbell Soup, the effects across the sector will be felt. European name AB InBev already felt the impact, opening lower in Europe.

Some other thoughts on Kraft:
- Piper writes they were "overly optimistic" on the conglomerate’s prospects as a consolidator in the sector and the quality of growth it would see. Are no longer confident the company can ensure brand equity that is necessary to compete in the current environment
- "The driver of the reduced profitability ironically was non-commodity-related cost inflation net of savings," Deutsche Bank analysts wrote, while acknowledging the synergies related to the merger were "unrealistic"
- UBS, in a downgrade to a neutral rating, wrote that results were "thesis changing". The dividend cut was the "right action" to help reduce debt levels
- KHC was also cut at JPMorgan, which wrote that "we might have maintained"our overweight rating despite the chaotic day, assuming they still had confidence in the strategy. However, they voiced concern that as leverage comes down, it may go right back up when another deal is completed. They "no longer" see a case for a "compelling upside"

But beyond those bombshells, there wasn’t much else in the way of a market direction Thursday (though lower for much of the day), and the moves were broadly limited to very company specific themes -- you don’t have to look far to find a lot of double digit moves on the tape.

What was interesting, however, was that this week marked the first week of emerging market equity outflows since October 2018, according to BofAML strategists led by Michael Hartnett, citing EPFR global data. U.S. equity funds posted the 12th week of outflows at $4.3b, comprised of inflows into U.S. growth and outflows in U.S. value, small caps and large caps. Strategists determined that “sell-into strength” was the most rational trade today.

Bet on Black

The gaming sector, though sleepy in the past couple years, is mounting a resurgence in the U.S. after what seemed to be an over-reliance on growth in Macau. Sports and online gambling (and online sports via ‘daily fantasy’), M&A discussions too, are piquing investor interest, and for good reason (Carl Icahn, and Tilman Fertitta of Landry’s and Golden Nugget fame have made recent investments in CZR, seeking to promote transactions in the sector).

Both Caesars (showing top line growth in Las Vegas and in other parts of the U.S.) and Boyd Gaming both surprised to the upside (Boyd recently entered into a strategic partnership with FanDuel Group, the online fantasy gambling co.), while gambling products and services provider Scientific Games also beat, rising more than 13% at one point Thursday, reaching levels not seen since September. Caesars was generally tight-lipped about the activist involvement on the conference call, as expected, but hasn’t shut the door or attempted to poison the well, which should at least keep shares supported in the near term. Credit Suisse wrote earlier in the week that this strategic interest "should act as a backstop," and the valuation in CZR ignores its real estate value.

On Tap for Next Week

Earnings season has gone the way of the Dodo, but you best whisper when in the company of consumer-focused investors who are expected to endure a catalyst-laden week. Earnings will run the gamut, from culty-names SHAK, CROX and ETSY (though arguably more tech-ish -- with growth to show for it: +145% in the past year) to economic bedrocks including HD, LOW, BBY. Consumer health will also be measured in disposable income via JCP, TJX, GPS and Macy’s results.

From the tech side of the equation, Square and Box are also due -- two names that tend to be volatile around earnings with heavy analyst attention. SQ’s last two results led to moves near 10%, while Box, over the past four earnings results, is averaging moves of more than 10% to the downside in the session following results. Canadian banking season also kicks off with Bank of Nova Scotia on Monday (RBC’s results just hit the tape are inline with expectations), while the other majors follow throughout the week.

If you’ve missed your Congressman, you’ll get plenty of them on your TV screen Tuesday and Wednesday as FOMC Chair Powell is set to sit before the Senate and the House for what feels like an all-day affair of possible political grandstanding. Given each word of the latest minutes has already been given the fine-toothed comb treatment, the political fireworks will likely be reserved for when the U.S. Trade Rep Lighthizer gets his own spotlight, testifying Wednesday before the House of Representatives on the state of trade talks with China. The timing won’t be lost on Congress as President Trump’s tariff "deadline" (that is likely to be extended by 60 days) fast approaches that Friday.

Also Friday comes a crucial test for Tesla (one can never count Musk out). Its oft-discussed $920 million convertible bond repayment is due, and with it, a big decision. It may be a bit presumptuous, but it looks like they may have difficulty reaching the $359.87 share price (>20% rally from last close), especially after the latest Consumer Reports release on its Model 3 sent shares down 3.7% Thursday.

A couple key conferences and presentations will be sprinkled throughout, starting with the BMO Mining and Materials conference that gets going before the market week even begins (Sunday!). Barrick, Newmont, Freeport, Alcoa and Rio Tinto will be watched for signs the global economic engine has turned. JPMorgan’s investor day is huge, though Deutsche Bank analysts noted they do not expect any material strategy changes -- instead, watch for news on that "JPM coin," its retail market and the online trading environment. For other key questions, see my colleague Felice Maranz’s piece earlier this week here. The Mobile World Congress (wireless charging anyone?) and SVB-Leerink healthcare conference will also boast some key names to watch.

Sectors in Focus Today

Packaged foods (MDLZ, K, POST) as KHC earnings and SEC investigation sent shares reeling, and are poised to open at an all-time low
Solar stocks (SEDG, SUNW, SPWR) after FSLR’s margins and net sales missed expectations
Cloud names after DBX’s operating margin views missed expectations
Optical names after results from ACIA, AAOI following LASR Thursday
SNC Lavalin’s results given the recent political developments and issues at its mine unit that sunk shares more than 30% in January

Notes from the Sell Side

Lam Research is trading lower by nearly 2% after getting a downgrade by Morgan Stanley analysts which expected the weakness in memory to push further downward revisions to spending this year and into next. Analysts led by Joseph Moore wrote that the sentiment that in the segment is nearing a bottom appears "too optimistic." He sees possible headwinds beyond the 1H as "intensifying." The rating goes to equal-weight from overweight.

Meanwhile, Moore and his team were busy upgrading shares of Intel to overweight, the shares of which are poised to open higher by nearly 3%. The move to overweight marks the first time in 7 years the analysts have been something other than neutral or negative on the chipmaker. He cites the enterprise value ratio to sales as "too low." Its idiosyncratic opportunities, including a financially minded CEO vs one "enamored with technology," could optimize free cash flow, drive higher M&A accretion and divest underperforming units, which can set the tech giant apart from other semiconductors, the analysts wrote.

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