Equity View: Earnings Reports Portray Strong Consumer, Year for Rebuilding

Summary

• We review the key macro themes emerging from Q1 earnings season.
• No companies are talking about recession risks now. But their outlooks are also mostly consistent with sluggish 1.5-2.0% GDP growth.
• Consumers are spending on staples and discretionary services but are still not buying goods.
• AI hardware may be red hot, but the broader AI bonanza is looking more like a 2025 event. Still, tantalizing hints of an ‘AI of Everything’ world are appearing.

Market Implications

• Company earnings reports suggest 2024 will be a rebuilding year, emphasizing cost cutting and adjusting to the new post-pandemic norm.

Big Picture Themes

Several macro themes emerged from the latest earnings season. At the top level:

• No companies have mentioned concerns about recession risk.
• But…many outlooks seem to envision a 1.5-2.0% GDP growth scenario in 2024.
• Many companies look to grow earnings through cost cutting rather than pursuing new markets or sources of demand.

Consumer Sector Is on a Roll

Consumer Staples – Surprisingly, many consumer staples companies reported solid beats and optimistic outlooks. Even companies focused on more expensive name-brand products are doing well.

Supply chain and inventory problems have eased, and inflation is less of a problem. And full employment means people have money to spend – although discount retailers report a growing share of their business is coming from higher-income households looking for deals.

Two companies that stand out for softer results are Pepsi Co (PEP) and Kraft Heinz (KHC). They reported lower volumes that they were unable to offset with higher prices. These companies were among the most aggressive in raising prices when the inflation shock hit. Now, they may be paying the price for their greed.

Consumer Discretionary – Walmart (WMT) encapsulates the status of the broader consumer discretionary sector. It reported better-than-expected results and outlook, largely because it has focused on investing in the grocery side of its business. Demand for consumer discretionary goods (electronics, apparel, toys) remains soft.

Companies in the travel-related business generally report solid demand. These include cruise operators, travel companies, hotel operators. However, some have reported softer outlooks than analysts expected, leading to selloffs in their stock. It is hard to know whether companies are managing expectations downward so they can post easy beats later this year or if expectations simply got inflated. We think demand overall is stabilizing and returning to pre-pandemic norms after the boom that followed the easing of pandemic lockdowns.

This adjustment may hurt some equities, but it is good for the macroeconomy.

AI Boom (Still) Around the Corner

The undisputed winner of the AI boom has been Nvidia. Many other companies have tried to grab the AI coattails, talking up emerging opportunities for them in the AI space. Among them are Intel (INTC), SalesForce (CRM) and SnowFlake (Inc).

All three cut their outlooks for 2024 while continuing to beat the AI drum. INTC inked an agreement with NVDA to supply network equipment to AI-oriented data centres – but also said AI revenue would be a late 2024 or 2025 development. CRM and SNOW may just be managing expectations downward. But it has been expensive – SNOW sold off by 20%; INTC fell 12%. CRM initially fell about 4% then gained on a view that its guidance was simply conservative.

Apart from companies like NVDA and Advanced Micro Devices (AMD) that are selling the hardware needed to implement AI apps, we think the AI bonanza will take time to spread to other tech and software companies.

AI of Everything?

Farm equipment manufacturer Deere and Co (DE) offered up a disappointing outlook due to falling agricultural prices. But to talk up its prospects, it said it is developing autonomous tractors and spreaders that incorporate AI to identify weeds versus crops.

DE certainly does not have a large staff of software and AI experts to develop this kind of technology inhouse. DE will be working with tech companies that specialize in developing these kinds of apps.

Key takeaways – First, it may take another five years or so, but if AI will be embedded in even mundane farm equipment, then surely it will become integrated into our lives in ways most of us can hardly imagine. ‘Internet of Things’? More like ‘AI of Everything’.

Second, the AI bonanza may not really hit in 2024, but it is coming. Now, just to pick the companies that will be building those apps that DE needs to build out its next generation of farm equipment…

Freight Recession Yet to Ease

Companies in the business of moving stuff (rails, trucking companies) continue to say we are in a freight recession. For whatever reason, industrial companies and retailers are in some steady state; they just are not increasing orders for more new raw materials or goods to sell. Some are still working off inventory accumulated when supply chain problems were rife. Others are simply cautious.

The one glimmer may come from the Mideast war and blockage in the Red Sea, which is diverting ships and may lead to a need to move goods over land instead of by sea.

Apart from that, a sluggish freight industry suggests much of the broader economy will be sluggish too.

Commodity Chip Companies Still Hurting

NVDA and a few other chip companies are booming. But a broad swathe of companies that make commodity-type chips used in PC, autos, countless appliances, and even mobile phones generally report soft demand for their products.

Some manufacturers of these goods are still working off inventories. Others say demand for consumer electronics remains soft as consumers are either spending on experiences and services, or simply do not need these kinds of goods yet after buying them during the pandemic.

We have yet to see a clear indication of when demand for commodity chips might pick up again.

Wrapping It Up

Judging from corporate earnings reports so far, 2024 is shaping up to be a rebuilding year – cutting costs, adjusting to the post-pandemic norm, and establishing the infrastructure to support whatever the brave new world of AI will bring.

Apart from DE, we heard little from companies about their plans or visions for incorporating AI into their business – other than that they are thinking about it. We look forward to hearing more in coming earnings seasons.

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Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)