It was yet another rough week on the markets. In fact, some major indexes had the highest levels of volatility we’ve witnessed in more than a decade.
The reasoning? US inflation came in higher than expected. We want to reiterate that inflation only came in higher than expectations; it did not come in higher than July’s levels. This is something we are seeing many investors get wrong.
Consensus estimates were 8.1%, whereas actual numbers came in around 8.3%. This is down from the 8.5% witnessed in July and the 9.1% in June. In a previous newsletter, we had predicted inflation had peaked in June. We’re sticking with that theory today.
Make no mistake about it; the United States and Canada cannot function properly at these inflation levels. But, a glass-half-full attitude here is that inflation has decreased for 3 straight months, highlighting that interest rate hikes are currently working.
On the other hand, US inflation coming in higher likely means that there will be a significant jump in US interest rates. We will know this by the end of the week. We will also know the inflation rate here in Canada, as it will report its Consumer Price Index mid-week.
Either or, we’re pretty confident the last 75 basis point (0.75%) hike by the Bank of Canada will not be the last. If inflation comes in higher this week, both countries could likely ramp up interest rates even further than predicted to continue the fight against inflation.
Ultimately, this will cause large market volatility, potentially even more significant than we see now. Now more than ever, it is essential to eliminate emotions from your investing decisions, as generally, the more volatile the markets, the more significant the consequences of knee-jerk reactions.
Mat and I continue to invest regularly during the turmoil, as it allows us to buy companies we like at cheaper prices.
Let’s move on to a couple of earnings reports from Premium companies this week, along with an important company down south issuing a warning about the US economy.
FedEx warning
On Thursday after close, FedEx (FDX) warned investors that their upcoming first quarter wasn’t going to be a good one. At times, when a company is going to report results that are big misses, they’ll issue a warning beforehand and that is exactly what FedEx did this past week.
As a result, their stock price dropped by 21.4% on Friday. Why was Friday’s news so important? As a shipping company, FedEx is often used as a bellwether for the US economy. Strong results typically mean that the economy is humming along. On the flip side, weak results could mean that the economy is struggling.
Let’s dig into the details. First off, the company expects Q1 earnings of $3.44 per share, well below consensus estimate of $5.14. Likewise, revenue is projected to come in at $23.2B slightly below the consensus estimate of $23.52B. Looking further out, it is expecting Q2 earnings of $2.75 per share, way off the consensus estimate of $5.46, and revenue of $23.5B-$24B versus consensus estimates of $24.87B.
Secondly (and more importantly), the company withdrew full-year guidance. Remember, the markets don’t like uncertainty and there is nothing that causes panic like a company pulling guidance.
We saw that at the outset of the pandemic multiple times, and FedEx is one of the first giants to do so on the back of “Global volumes (which have) declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S.”
To combat these issues, it is undertaking significant cost savings initiatives such as reduction in volume-related reductions in labor hours, deferral of hiring and CAPEX, and the closure of over 90 FedEx Office locations. It also plans to shutter five corporate office facilities.
Specifically, the company pointed to macroeconomic weakness in Asia and service challenges in Europe, resulting in a revenue shortfall of ~$500M compared to FDX’s outlook while FedEx Ground revenue came in ~$300M lighter.
We didn’t get much more than that, but the company isn’t reporting until Thursday of this week. We are sure that their conference call will be one of the most anticipated in quite some time.
Why the FedEx warning has a silver lining
If FedEx is the first warning shot about a cooling economy, there is a silver lining. A recession is never going to be a good thing for the markets, but it may also mean that the Fed’s pace of interest rate hikes is having the desired effect.
This could be good news in the long run as it could lead to some sort of rate stabilization in the near future. That said, the Feds make their decisions on lagging indicators so we may still be 3-6 months out from this type of stabilization.
An economic slowdown was inevitable. In fact, it needed to happen in order to avoid a complete disaster when it comes to inflation. So, FedEx reporting a slowdown is not a surprise to us. And as long term investors, we’re not all that worried about the company’s comments because with a long-term time horizon on our investment decisions, all a slowdown means is we will be able to add companies to our portfolios for cheaper.
Is FedEx a buy today? This is a tough call
Many members have been asking us if FedEx is a buy after this drop.
While the company looks cheap based on a historical basis thanks to its 21% dip, it did just issue guidance in which the first two quarters are likely to come in almost 50% below estimates. Analysts have already begun lowering estimates, but we imagine the bulk of revisions won’t come until post Q1 conference call.
With that in mind, you can throw all historical and future valuations out the window at this point. We also wanted to mention that FedEx is prone to wild swings. It suffered a 65% drawdown during the Covid crash and has several 30%+ drawdowns in its history. With Friday’s drop, it is now sitting on losses of approximately 36% year to date.
That said, we’d be in no rush to run out and grab FedEx post-dip. As mentioned, the markets don’t like uncertainty and after pulling guidance, there is nothing certain about FedEx’s near-term outlook.
Enghouse Limited (TSE:ENGH)
Enghouse reported earnings that failed to hit the mark for the third consecutive quarter. Earnings of $0.33 missed by $0.04 and revenue of $102M came in short of the $107M predicted.
This marks the sixth time in 6 quarters that Enghouse has missed on earnings expectations, and the 9th straight quarter in terms of revenue. YoY, the company saw declines across the board, including operating cash flows which dropped from $125.4M in Q3 of last year to $107.3M this year.
As a serial acquirer, Enghouse has lagged behind its peers as many have ramped up acquisitions leaving Enghouse in their wake. The good news is that we are slowly starting to close on acquisitions and it has ample room to ramp up deals as it exited the quarter with a cash horde north of $225M.
We continue to be patient with the company, as both Mat and I own. We believe there is a large margin of safety here at today’s levels even if growth was in the low single-digits.
We highlight our discounted cash flow calculations inside of our report, which you can read here.
BRP Inc
BRP had a strong rebound quarter after posting mixed results in Q1. The company topped revenue expectations by 5.92% and earnings by 11.78%.
Revenue of $2.439B marks a 28% increase from one year ago, and normalized diluted EPS of $2.94 was up 2% over the same timeframe. The company continues to post market share gains in the Side-By-Side Vehicle segment despite its products being limited in terms of availability.
BRP is a company that maintains consistent and in-depth guidance. And for the most part, all eyes were on how the company felt it would close out the year. The good news for investors is that BRP raised its guidance on practically all fronts. The company now expects total revenue to grow by 26-31% (previously they had projected 26-29%). It also expects earnings per share to come in at $11.30-$11.65 (previously they had projected $11-$11.35).
Overall, the company continues to do its thing and is showing little to no signs of slowing down. We believe it is an excellent time to accumulate.
