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Plus, Eli Lilly’s Long-Term Obesity Bet
Happy Sunday to everyone on The Street.
She loves me, she loves me not. She loves me, she loves me not. A recession is coming, a recession is not.
Predicting a major downturn feels a bit like picking pedals off a flower at the moment.
On the one hand, the regional banking crisis that is currently unfolding is sending some ominous signals. It feels like we're in the early innings too, so I'm not sure what other shoes will drop in the coming days, weeks, and months.
On the other hand, there are random and obscure data points that seem to indicate the economy is fine and trucking along. One of those beacons is, in fact, heavy truck sales, which jumped 23% from a year earlier.
Now, this data point alone doesn't mean much, but it is an interesting pedal to pick at. During the great recession, heavy truck sales fell to a low of 180 thousand SAAR in May 2009. Then they climbed their way back to a new all-time high of 570 thousand SAAR in April 2019.
Sales plummeted again at the beginning of the pandemic, falling to a low of 308 thousand SAAR in May 2020. But they were back at 563 thousand SAAR this past April.
Zooming out, heavy truck sales tend to decline sharply prior to or during a recession, which makes the April spike worth watching. In terms of what this data point means for our flower-related recession game, right now it's still pedal to the metal.
— Brooks
Review
US stocks finished higher Friday on the back of a rebound in regional bank stocks and positive quarterly results from Apple.
The tech titan beat both top-and-bottom line estimates with earnings per share of $1.52 and revenue of $94.84 billion, compared to the expected $1.43 and $92.96 billion, respectively. The positive numbers were driven by stronger-than-anticipated iPhone sales of $51.33 billion. However, the company’s overall sales fell for a second consecutive quarter and it continued its trend of forgoing formal guidance.
Meanwhile, Warner Bros Discovery reported a sizable loss of $0.44 per share compared to the expected $0.01 gain. Despite its HBO Max streaming service ending the quarter with 97.6 million subscribers and a $50 million profit, the company lost $930 million in free cash flow, primarily due to interest and sports media rights payments.
On the economic front, the unemployment rate fell to 3.4% in April compared to market expectations of an increase to 3.6%. The figure matches the 50-year low previously seen in January. The US economy unexpectedly added 253,000 jobs, notably surpassing forecasts of 180,000, though still below the six-month average of 290,000. The bulk of the jobs came from services, health care, and hospitality sectors.
In company-specific news, beleaguered used car retailer Carvana said it expects to achieve positive adjusted earnings during the second quarter of this year. After overspending in 2022, the company saw its stock fall by roughly 98%, but it has since instituted a restructuring plan in its quest toward profitability.
In total for the week, the Dow Jones Industrial Average fell 1.24%, while the S&P 500 was down 0.80%. The Nasdaq Composite, however, finished 0.07% higher.
Preview
Tomorrow the wholesale inventories report for March is due along with the Q1 Fed Senior Loan Survey.
Tuesday, investors will get two different optimism indexes, one for the economy and one for business. In April, the Economic Optimism Index rose for the third consecutive month while, in March, the Small Business Optimism Index fell to a three-month low.
On Wednesday, the closely-watched inflation rate will be released for the month of April. In March, inflation slowed for the 9th consecutive month to hit 5%. While inflation has been declining, it’s still more than double the Fed’s 2% target rate. Additionally, investors will get an update on the 30-year mortgage rate, which currently sits at 6.5%.
On Thursday, the report for producer prices will be released. This inflation metric dropped 0.5% in March which was the biggest decline since April 2020. However, 66% of this decline can be attributed to a drop in the price of gasoline. Investors will also get an update on jobless claims, which rose 13,000 to 242,000 for the week ending April 29th. This was higher than expected.
On Friday, the week will round out with the release of monthly figures for import prices and export prices. In March, import prices fell 0.6% while export prices fell 0.3%.
Earnings Spotlight
Tomorrow, alternative asset management company KKR (KKR) will kick off another busy week of earnings.
Tuesday, Airbnb (ABNB) will provide investors with more details about its recently-released platform updates. Additionally, Electronic Arts (EA), Allbirds (BIRD), ZipRecuiter (ZIP), and Rivian (RIVN) will also offer earnings reports. While many EV makers cut prices due to increased competition in the industry, investors will hope for an optimistic report from Rivian. The company delivered almost 8,000 vehicles in Q1.
On Wednesday, investors will get earnings reports from Beyond Meat. Investors will look for clues as to the state of the plant-based meat industry, which has been stagnant since 2020. Also reporting: a little local publication called the New York Times (NYT) and an entertainment company you may have heard of named Walt Disney (DIS).
On Thursday, consumer-facing companies Yeti (YETI) and Krispy Kreme (DNUT) will round out the week by updating investors on their respective businesses.
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Kenvue IPO May Be Just What The Doctor Ordered
Johnson & Johnson’s New IPO
Consumer healthcare might not come to mind when discussing a hot IPO. But maybe it should, particularly in the case of Kenvue — or, KVUE as it's now known by the New York Stock Exchange.
The Johnson & Johnson (JNJ) spinoff owns Tylenol, Band-Aid, and Listerine, among other household names. It will pay a dividend of >3.5% based on a planned quarterly payout of around 20 cents per share and brought in $3.8 billion from its stock market debut. That’s more than all of the money raised from IPOs this year combined, according to Renaissance Capital.
“Kenvue checks a lot of boxes for the type of IPO that should work right now. It’s a large company, with a portfolio of market-leading brands, that generates a ton of cash flow,” Matthew Kennedy, a senior strategist at Renaissance told Barron’s in a recent interview. “It’ll offer a healthy dividend, and the valuation looks fair.”
Long gone are the days when you had to be a fast-growing Silicon Valley tech startup to net investor attention. The IPO market has languished of late. Investors today appear to focus only on companies that are growing at a consistent rate — and aren’t sitting on significant debt.
Clean Bill of Health
Kenvue fits that bill. Annual sales are expected to grow around 4%. Far from high flying, but still consistent. Excluding currency swings, it had the same growth in 2021 and 2022. For the first quarter of 2023, adjusted earnings came in at $630 million, or 33 cents per share — growth of 3% year-over-year.
There are a couple complications to the Kenvue story: spinout costs from J&J and the overall cost of operations. Under its own ticker, Kenvue now must hire its own accountants, marketers, and board, as well as pay 5% interest on its debt. All of that could weigh on adjusted earnings this year. Then there’s its ownership structure. J&J owns about 90% of Kenvue following the IPO. The remainder should be distributed to holders later in the year.
Shares Look Cheap
Despite those complications, KVUE could be just what the doctor ordered. Healthcare might be known for its high costs, but this is a trend that Kenvue appears to buck.
Shares are priced at 16x trailing adjusted earnings for 2022, below the 18.5x multiple for the S&P 500 Index. Coca-Cola (KO) and Procter & Gamble (PG), other major consumer goods companies, trade around 25x earnings. And Kenvue rival Haleon (HLN), which owns Sensodyne, ChapStick, and Advil, has a multiple of 20x trailing earnings.
Given Kenvue’s prospects, one may wonder why J&J is spinning it off in the first place. Usually, a company does so to unlock value (which is ostensibly the case here) or offload underperforming asset. Neither is really the case here. The move is costing J&J $2 billion and $500-$750 million of annual after-tax dis-synergies. J&J and Kenvue management says it will help the company focus and be more nimble, though some argue it already is.
Regardless, one thing is for sure: it's a much-needed defibrillator for the IPO market.
Are you bullish or bearish on KVUE over the next 24 months? |
Credit Card Companies Cool With You Swiping Less
Discipline > Defaults
Conventional wisdom says a pullback in spending would hurt credit card companies, since it means less revenue in fees and interest. But in the current environment, investors appear to actually be applauding discipline on the part of credit card holders.
In the past few weeks of quarterly results, a handful of credit card issuers reported signs consumers were spending less, including Capital One (COF), American Express (AXP) and Citigroup (C). This should’ve spooked investors, but it didn’t. That could be because less spending implies a bigger buffer against defaults in the case of a coming recession. In other words, it’s okay if credit card companies give up a little growth now if it means they won’t have to deal with an uptick in late payments and loan losses if the economy sours.
“In the spirit of, what are we rooting for, it seems to me to be a pretty rational thing for consumers to sort of level off this pretty strong spend that they have had,” Capital One CEO Richard Fairbank told analysts on its recent earnings call.
Spending Up… On Credit Card Stocks
Investors appear to agree. An index of consumer finance companies in the S&P 500 — which includes American Express, Capital One, Discover Financial Services (DFS), and Synchrony Financial (SYF) — is up close to 6% year-to-date. Banks in the S&P 500 have dipped 10% in the same period.
Slowing spending on the part of consumers may mean fewer fees, but it could also signal to the Fed the time to pause rate hikes is on the horizon. “The spending slowdown … is also leading to less demand and lower prices, which combats inflation and helps the Fed,” KBW analyst Sanjay Sakhrani told investors.
Plus, credit card issuers are already prepared for a slowdown. Some reported bigger-than-anticipated reserves against loan losses in the first quarter, likely built up to offset the risk of a historically-low unemployment rate correcting by year’s end.
CCall for CConcern?
As recessionary concerns abound, the path ahead for credit card companies may prove rocky yet. But, for now, credit risk remains okay.
30-plus-day delinquency rates are on the rise, though they remain around normal pre-pandemic levels. This could prompt credit card issuers to release some of the extra reserves they built up, which would lift earnings in the future.
On the other hand, if consumers continue to spend less but the Fed refuses to pause rate hikes, balances could grow exponentially with interest, spurring a recession. If that happened, credit card stocks could decline.
For now, though, CC companies are holding steady. Less spending may mean less swiping, inserting, or tapping. But credit card issuers and investors alike seem to agree consumer discipline is better for the economy long-term.
Which stock will outperform over the next 12 months? |
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Is Obesity Chronic? Eli Lilly Thinks So
Eli Lilly’s Long-Term Bet
A crop of weight loss drugs originally used to treat diabetes is helping many successfully shed pounds. But Eli Lilly (LLY), maker of the type 2 diabetes treatment tirzepatide sold as Mounjaro, believes keeping them off is a different story. The pharmaceutical company believes obesity is chronic — and, if it can convince insurers of the same, plans to capitalize on it.
Eli Lilly is in clinical trials to use Mounjaro for weight loss. It is expected to get the nod from the FDA later this year. If it does get approval, it will need to convince insurers that weight loss is chronic and patients will have to remain on the drug after the pounds are gone or risk gaining it back.
“On the commercial side, as we launch into the chronic weight management market for tirzepatide, we’ll be very upfront with payers and health-care professionals and consumers that this is a chronic disease and a chronic medication that needs to be adhered to long-term,” said Michael Mason, head of Lilly’s diabetes unit, on a earnings conference call last week.
Is Weight Loss Perishable?
As it stands, private insurers will only cover weight loss drugs for a predetermined amount of time. Meanwhile, Medicare doesn’t cover weight loss medications at all.
This presents a challenge for Eli Lilly, but it’s one the company and Wall Street analysts alike think it can overcome. The way Eli Lilly sees it, drugs will eventually become the preferred method to treat obesity. Analysts agree. Eli Lilly has been increasing near term sales targets for tirzepatide based on type 2 diabetes patients alone. Add use for weight loss in the mix and you can see why some are so giddy.
Eli Lilly and Novo Nordisk (NVO), maker of weight loss med Wegovy, are both making the case to insurers by highlighting the fact that treating obesity will reduce other diseases and illnesses over time. This could actually save insurers more money in the long run.
Both companies are conducting trials to prove it. Novo and Eli Lilly are testing to see if these drugs can help prevent strokes and heart attacks in diabetes patients, and/or soothe sleep apnea and osteoarthritis in the knee.
Eli Lilly’s Edge
Eli Lilly and Novo are currently in the lead. Novo was the first to get approval to use its drug for weight loss, but Eli Lilly’s treatment has been marginally more effective in clinical trials.
As a result, analysts are focused on Eli Lilly and quarterly results for Mounjaro. Sales were better-than-expected in the most recent quarter. JPMorgan analyst Chris Schott thinks this trend will continue in the second quarter, and that sales could increase even more in the back half of the year.
“LLY continues to represent our favorite pick in the group as we see meaningful upside to Street estimates for Mounjaro and LLY’s broader incretin portfolio over time as well as a favorable setup on the stock heading into a number of important catalysts in 2023 and early 2024,” wrote the analyst in a research report.
Eli Lilly now finds itself in a classic — and potentially very profitable — position for pharmaceutical companies. First, find patients seeking treatment. Then, develop one. Finally, convince them (or their insurers) to pay you for it, indefinitely, if possible.
Are you bullish or bearish on Eli Lilly (LLY) over the next 12 months? |
Last Week's Poll Results
Are you bullish or bearish on TJX over the next 6 months?
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Which stock will outperform over the next 24 months?
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