🍺 Boston Beer, Offshore Drilling, and Student Loans

Happy Sunday to everyone on The Street.

I’m repurposing what I wrote for our daily newsletter, The Flag, ahead of my favorite holiday of the year. Have a wonderful time celebrating this beautiful country with your friends and family.

We are officially halfway through 2023. Wild! But it’s cause for celebration, as is the weekend before our favorite holiday of the year: July 4th.

Our independence from Britain 247 years ago made the world a better place. Before the United States, much of the Western world was organized in a vertical order known as the “Great Chain of Being” — a world ruled by priests and monarchs. It was a world in which, if you were born at the bottom, you had virtually no chance of ever making it to the top.

The Declaration of Independence, the Constitution, and the Bill of Rights took that existing framework and bodyslammed it against the ancient moral grounds it had been resting on for thousands of years.

The vertical order began to tilt, becoming just horizontal enough that, if you were born into a poor Mississippi family in 1954, you could go on to host a TV series called The Oprah Winfrey Show and end up with a net worth of $2.5 billion. Or, you could be the child of two immigrants and become a millionaire by age 23, giving the world the iPhone along the way, like Steve Jobs.

And the tilt didn’t end at the US borders. Our country’s inception compelled humanity to think about concepts like equality and individual rights. It provided a framework for a new economic model called capitalism — which, say what you will, has lifted more people out of poverty than any other framework before it.

Now, we still have a lot of work to do. A lot. Our country is far from perfect. But, if you’ve spent much time outside the United States, you probably know, all things considered, we have it pretty okay back home. Which might be why more than 40 million people living in the US were born in another country, accounting for about one-fifth of the world's migrants.

Nothing is easy. Nothing is perfect. But on a relative basis and historical terms, we think the world is much better now than it was before 1776. At the very least, we don’t have to answer to a King this weekend. And that alone, even 247 years later, is worth celebrating.

Thanks for listening to us ramble. Enjoy the holiday and the amazing country we get to call home.

Before we go, as all of you know, we are HUGE fans of American history. Which is why we’re excited to be partnering with Rally, a platform for buying & selling equity shares in collectible assets. Looking for a '56 Mickey Mantle card? Rally has it. How about a '54 Hank Aaron card? Yup. Take a look for yourself: the nostalgia kick is a July 4 celebration in itself.

— Brooks

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Review

US stocks finished higher Friday to close out the second quarter and first half of the year on a high note.

On the economic front, Wall Street received the latest numbers for the Fed’s favored inflation index, core PCE, which saw a 0.3% increase in May. This was in line with market expectations and signaled a slight easing from the previous month’s 0.4% increase. On a yearly basis, the index rose by 4.6% compared to the previous month’s 4.7%. However, headline PCE for May saw an encouraging decline from 4.3% to 3.8%, the lowest reading since April 2021.

Meanwhile, personal income in the US rose 0.4% month-over-month in May. This was slightly above expectations and largely driven by a 0.5% increase in compensation from private wages and salaries. While good news for workers, the wage gains could be seen as counterproductive to the Fed’s fight against inflation.

Personal spending also edged higher by 0.1% month-over-month but fell short of expectations of 0.2%. Overall, there was a $52.0 billion increase in spending for services, but this was partly offset by a $33.1 billion decline in spending for goods.

In company-specific news, Google announced it will block Canadian news outlets from appearing in search results and other products in the country after the passage of bill C-18, which would require Google and Meta to pay newsrooms for linking to their content. The bill stood to bring in $329 million for Canadian newsrooms annually. But Google and Meta argue the framework of the new law would expose them to, quote, "uncapped financial liability.”

In total for the week, the Dow Jones Industrial Average finished 2.02% higher, while the S&P 500 surged 2.35%. The Nasdaq Composite was a close second at 2.19%.

In total for the first half of the year, the S&P 500 rose 15.9% — its best first half since 2019. The Nasdaq advanced 31.7%, for its best first half since 1983. The 30-stock Dow, on the other hand, increased by just 3.8%.

Preview

Tomorrow, the ISM manufacturing PMI for‌ June will be released. This metric dipped slightly in May, marking the seventh straight month of contraction in the manufacturing sector.

Tuesday, markets will be closed as companies, consumers, and investors alike push pause to celebrate US Independence Day.

On Wednesday, the minutes from the Federal Open Market Committee will be released. This will give investors more insight into the central bank committee’s stance on rate hikes moving forward. Most policymakers still expect at least two more rate hikes through the end of the year, despite the pause in June.

There will be a flurry of economic reports released Thursday. Among them: ISM services PMI, JOLTS job openings, and the current trade balance. Notably, in April, the US trade deficit widened to a six-month high of $74.6 billion. On top of those, investors will get an update to the 30-year fixed-rate mortgage, which currently sits at 6.75%.

On Friday, the unemployment rate for June will be released. In May, unemployment ticked up to 3.7%, the highest reading since October 2022. Despite hitting a recent high, unemployment still sits near historic lows. It may need to show a more significant rise for the Fed to pivot to more dovish policy decisions.

Earnings Spotlight

Due to the Fourth of July holiday, few companies are expected to report earnings this week.

That said, on Wednesday, Safeway-owner Albertsons (ACI) will report. The grocery store conglomerate is sure to offer its perspective on its pending sale to Kroger (KR), which would create the largest grocer chain in the nation. As such, the acquisition has faced backlash from workers’ unions, lawsuits from customers, and an ongoing investigation by the FTC.

On Thursday, Levi Strauss & Co (LEVI), the manufacturer of Levi’s jeans, will be one of the few companies this week to offer investors an update on its business. During the call, the legacy clothing maker will likely discuss its sustainability efforts and recent initiative to develop more easily-recyclable jeans.

And, on Friday, Urban One (UONE), a Maryland-based media conglomerate, will report earnings. The largest Black-owned broadcasting company will likely discuss its recent acquisition of several Houston-based radio stations.

Boston Brew Looks Beyond Beer for Growth

Truly Hangover Subsiding

Boston Beer (SAM) is trying to shake its hangover, relying on canned cocktails, hard cider, and flavored malt beverages to drive growth. It's a much-needed shot with sales of its hard seltzer brand Truly projected to fall double digits this year.

During the pandemic Truly was all the rage, sending Boston Beer’s earnings soaring 70%. That quickly fizzled out once lockdowns ended, leaving Boston Beer with disappointing sales and excess inventory.

For 2023, the company expects hard-seltzer volumes to fall in the mid-teens percentage range. Still, the company has a reputation for being an early player in new alcoholic beverage categories. And, with many of them gaining popularity, it could drive growth beyond Truly — or, at the very least, offset the declines.

Twisted Tea the Next Rager?

Boston Beer only has about 5% market share in US beer sales. But, when it comes to the beyond-beer categories, its share jumps to 25%. A lot of that has to do with Truly, market leader White Claw’s closest competitor. But other Boston Beer brands like Twisted Tea are also taking off. The malt-based hard tea launched in 2001, and sales have grown every year since. It really took off in 2022 thanks to additional flavors, a larger distribution network, and more attention from retailers.

If Truly can stabilize, and Twisted Tea continues along its current growth trajectory, investors may be more willing to reward SAM by snapping up shares. That’s what Roth MKM analyst Bill Kirk thinks. He recently upgraded the stock to buy and raised his price target to $386, from $274. For context, shares closed at $308.44 on Friday.

Eyes on the Bottom Line

Boston Beer also has its eyes on operations, cutting costs, finding ways to save on raw materials, and pouring money into automation in its brewing and packaging processes. The company is targeting gross margins of 50% in three to five years. As of 2022, gross margins stood at 41%. Bulls like that. Analysts expect Boston Beer earnings to grow 35% this year, although revenue is projected to decline 3% to around $2 billion. By 2026, analysts see earnings coming close to its record in 2020.

With or without Truly, Boston Beer looks ready to serve up some wins. Now it just has to get investors to drink to that.

Offshore Drillers Are Down but Not Out

Things Are Looking Better

What a difference a year makes when it comes to offshore drilling stocks. During the pandemic, prices for oil plummeted, demand dried up, and the world started moving to greener energy. Rigs were taken out of commission and many offshore drillers were forced to file for bankruptcy.

For a handful of them, namely Noble (NE), Valaris (VAL), and Seadrill (SDRL), things are looking a whole lot better. They have emerged from bankruptcy into a strong financial position and are poised to benefit as large energy companies increase their spending on offshore drilling.

Bankruptcy Strength

You wouldn’t know it from the stocks — shares of the companies are down from highs seen earlier this year as oil prices wobble. Still, low oil prices aren’t expected to stop energy companies from pouring more dollars into offshore drilling. The offshore drillers, as a result, are in a position to cash in on high rates from leasing their rigs, producing better earnings for them and their investors in the coming years.

It doesn’t hurt that most offshore drilling companies have little or no net debt after restructuring their balance sheets in bankruptcy. They aren’t currently paying dividends, but some are buying back shares and could reinstate payouts in the future as free cash flow grows again.

“We are in the second year of what we view as a minimum of a five-year […] investment growth cycle,” Barclays analyst David Anderson wrote in a recent research report. He thinks offshore drillers are the most attractive way to play the energy market.

Upside in the Cards?

Anderson points to Nobel as one of his top picks. He thinks the company has a big recontracting opportunity over the coming two years. It doesn't hurt that it has no debt and is buying back shares. The analyst has a $56 price target on the stock, implying more than 50% upside.

Then there’s Valaris. Wall Street likes this company because of its rig joint venture with Aramco, the state-controlled Saudi oil giant, which could be spun out as a publicly traded entity. On the M&A front analysts point to Seadrill as a consolidator. It could also benefit from its $1 billion merger with Aquadrill which gives it access to advanced drills. Its low-price legacy contracts are also expiring, which could boost earnings in the years to come.

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Student Loan Borrowers to Reign in Spending

Got To Come From Somewhere

Student loan payments are resuming this fall after a three-year pandemic hiatus. And, with a major expense back on around 43 million Americans’ balance sheets, the money’s got to come from somewhere.

That could be bad news for some of the nation's retailers, particularly the ones hawking clothing and accessories, including Crocs (CROX), Gap (GPS), Nike (NKE), Victoria’s Secret (VSCO), American Eagle Outfitters (AEO), Urban Outfitters (URBN), and scrubs-provider Figs (FIGS).

Wall Street thinks the resumption of student loan payments will result in billions of dollars in lost consumer spending. Just how much? Deutsche Bank estimates consumer spending will drop by $14 billion a month, or $305 per student loan holder. Barclays thinks it could be as much as $15.8 billion a month, or $390 per borrower, in lost consumer spending.

Apparel Stocks on the Cost-Cutting Menu

Apparel companies, which have taken a hit amid high inflation, are expected to suffer the most. It's the number one area where cash-strapped consumers reign in their spending and is also a favorite among student loan holders. It doesn’t help that they prefer brands and specialty retailers over private labels and discounters. Barclays thinks the companies catering to college-educated shoppers ages 18 to 34 will experience the biggest hit.

“For most, this will be the first time making payments since the early days of the pandemic in March 2020,” Barclays analyst Adrienne Yih wrote in a recent research report. “We regard the incremental ‘essential’ nature of the debt payments as likely to reduce discretionary spending by an approximately equal amount.”

Nobody is Safe

Beyond apparel retailers, Wall Street thinks other retailers such as Target (TGT), Best Buy (BBY), Dicks Sporting Goods (DKS), and Ulta (ULTA) will feel the blowback from reduced consumer spending as student loan borrowers focus on their debt. They are already feeling the impacts of inflation and lower tax refunds. This adds to it.

“At a high level, we believe the company-specific impact follows (1) exposure to Millennial and Gen X customers (which account for ~69% of total student loans), (2) exposure to states with higher average student loan balances (primarily Northeast and Southeast), and (3) discretionary mix,” JPMorgan analyst Christopher Horvers wrote in a recent note.

Last Week's Poll Results

Do you think AI poses a major threat to music label stocks?

🟩🟩🟩🟩🟩🟩 👍Yes

🟨🟨🟨⬜️⬜️⬜️ 👎No

Are you bullish or bearish on Adidas over the next 12 months?

🟩🟩🟩🟩🟩🟩 🐂 Bullish

🟨🟨🟨⬜️⬜️⬜️ 🐻 Bearish

Do you think reshoring will be a net positive or net negative for the US economy?

🟩🟩🟩🟩🟩🟩 🐂 Net Positive

🟨⬜️⬜️⬜️⬜️⬜️ 🐻 Net Negative

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