Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
“Learnings from Earnings”
We are knee deep in earnings season here at MWM, and have been on nonstop conference calls as we listen to a deluge of information and gain understanding of the business prospects for our existing positions and ideas that are under consideration for investment. To be clear, we do not “play” earnings season, or try to make short-term investment decisions ahead of a quarter. Instead, by spending our time understanding long-term fundamentals, we can quickly take advantage of opportunities that the market might present because of the actions of “investors” with a much shorter investment time horizon. So today we’d like to present a smattering of key themes and observations from the first half of this third-quarter earnings season.
Operational hiccups in gold mining highlight scarcity value of high-quality assets: This quarter we have seen several senior and mid-tier gold producers miss production and cost estimates. We began to reflect on the individual problems and what they meant for investment prospects in gold mining companies as a whole. During the last bull market in gold, we saw tens of millions of dollars raised to build mines that had technical, geological, and/or jurisdictional problems. Because mining is fundamentally a long-cycle business, meaning that it can be almost a decade or more between the time a discovery is made until the time it goes into full production, it can sometimes take many years for these problems to become apparent to the market. We have seen many companies falter this earnings season due to these challenges and the balance sheet strain that underperforming assets can bring about. This highlights the scarcity value of high-quality, low-cost, high-return assets and management teams that are able to deliver and are very likely to attract M&A premiums as the production and reserves profiles for senior producers begin to decline going forward.
Energy remains for sale: The risk/reward in energy investing has remained lackluster despite very attractive valuation. We saw that several companies had solid beat-and-raise quarters and guidance that topped forecasts, and are experiencing declining capital spending, improving free cash flow yields, and even increased dividends, only to be met with a wave of selling. We are cautiously optimistic around energy stocks for 2020 given attractive valuations, peaking onshore production, and tightening supply/demand. Sentiment for this sector is as bad as we have ever seen it, despite the fact that crude prices have held up well. It is clear that momentum begets momentum, and we will need to see global inventories begin to draw before we see a sustained move higher in the stocks. However, we also think that M&A and consolidation will continue to be a theme for the sector as scale is becoming increasingly important in order to drive rates of return and investors look for answers to high G&A and executive compensation despite the lack of returns to shareholders.
The importance of e-commerce is not to be understated: The trend of shopper preference for online at the expense of brick and mortar shows no signs of abating. Same-store net operating income growth in malls continues to be anemic. While retail bankruptcies have begun to slow, 2019 has seen key anchor tenants in shopping center and mall properties rationalize space and close stores. According to CNBC.com, we saw net closures of over 5,200 stores nationwide. On the other hand, rental income growth continues to be robust for warehouse and industrial as the loss for retail has been a boon for this property type. Though there has been some supply growth in this area, it has been relatively muted, particularly in dense urban neighborhoods, and vacancies remain low. We are also seeing M&A in this area with one major REIT accretively consolidating a smaller operator into its asset base within the past couple of weeks, and about $40 billion in total transactions year to date.
All in all, it is an eventful time. We look forward to putting our themes and ideas to work for you. We thank you for your interest and are grateful for your continued support.
Best Regards,
David McAlvany
Chief Executive Officer
MWM LLC
