In this briefing:
- Tesla (TSLA) 3Q19 Earnings Impressions: Is Anyone Other than the CFO Flagging the JPY Weakness?
- Comprehensive US-China Trade Deal Crucial for Fed, Though It Won’t Fully Solve China’s Slowdown
- U.S. Equity Strategy: Is Fourth Time a Charm?
- Shipping Market: Picking the Winners
- Weekly Oil Views: Economic Gloom Caps and Locks Prices in a Narrow Range
To us one of the most useful information given out by Tesla in its 3Q earnings call was what many commentators following the call characterized as “one-offs.” As we listened to the replay and read through the call transcript, CFO Zachary Kirkhorn used the term rather loosely to refer to Tesla’s JPY exposure and its new Smart Summons feature that it rolled out in the last week of September.
We highly expect the biggest item on everyone’s discussion agenda following Tesla’s earnings surprise in 3Q undoubtedly will be how sustainable that 20% after market share price spike will be once the market has had a chance to digest it all. Here are our initial impressions without the benefit of having a detailed 10Q at our disposal (which by the time everyone reads it will unlikely impact share price performance much), and based solely on the company’s release and earnings call:
- 3Q margin improvement resulting from both ongoing cost structure improvements, higher realized ASPs for models S&X and several non-recurring items seemed reasonable in our view. This is because Tesla started out as such an inefficient final assembler that its peculiar brand of reinventing the wheel on automotive assembly should allow it to achieve significant improvements as it learns.
- One of two non-recurring factors that CFO Zachary Kirkhorn mentioned that impacted the company’s 3Q margins was FX. Because Tesla has JPY denominated procurements and the JPY was appreciating against both USD and EUR during 3Q we believe this makes sense. The other one-off factor mentioned by Kirkhorn was revenue recognition for the Smart Summons feature released in the last week of September, which he said was “debatable” as to whether it should be labelled as a one-off.
- At the operating expense level, there was no restructuring charge in 3Q so the absence of a one-off actually helped to achieve positive operating and EBITDA margins in our view.
- Broadly speaking however, we note that while Tesla’s direct distribution system incurs significantly higher SG&A burdens than ICE-focused OEMs, Tesla has managed to bring down its average SG&A/Revenue percentage to 12.7% this year from an average of 17.4% during the 2017-18 period.
Hence, without the benefit of having more detailed 10Q filings at present, we believe there are several risk factors that investors should broadly keep in mind regarding Tesla’s strategy: 1) unhedged FX exposure and 2) the doubled edged sword nature of keeping its direct distribution system, and finally, 3) there are balance sheet issues that remain so it is paramount that Tesla maintain stable free cash flow.
Because no quantifiable numbers on the Gigafactory 3 and China will be available until at least the company’s 4Q earnings release in late January/early February, we believe there will be plenty of opportunities for the stock market to engage in “buy on the dream, sell on fact” pattern of trading Tesla’s shares as we head into the final stretch of 2019. As we have mentioned many times in the SmartKarma forum, calling Tesla’s share price performance is tantamount to calling the market in our view.
China’s economic growth in Q3 registered its slowest rate since quarterly reporting began in 1992, but the deceleration cannot be solely attributed to the US-China trade dispute. Meanwhile, China’s exporters are examining ways to avoid the impact of US tariffs by searching for new markets and off-shoring production, but these efforts will take time to bear results.
Despite the weakening in the yuan versus the dollar since the beginning of the year, the US Treasury has refrained from accusing China as being a currency manipulator in advance of a comprehensive bilateral trade agreement. Recent US trade deals have incorporated clauses to outlaw competitive currency devaluations, but China is unlikely to accept yuan appreciation, similar to the Plaza Accord, as part of a trade agreement in order to avoid the experience of Japan.
Global equities (ACWI) and the equal-weighted S&P 500 are attempting to break out for the fourth time this year from what has seemed like a never-ending horizontal consolidation period. At some point this consolidation will come to an end, however the weight of the evidence is not yet telling us “this time is different.” Despite some recent encouraging and positive developments from areas such as retail (XRT), EM (EEM), and European Banks (EUFN), we remain in wait-and-see mode as the market approaches resistance. In today’s report we detail why we remain hesitant to call this a bull market along with what it would take to improve our outlook. We also highlight attractive Groups and stocks within Consumer Discretionary, Financials, and Materials: Retailers, Off-Price, Banks, Super-Regional, Construction Materials/Products, and Forest Products, Diversified.
- Container shipping: Despite the unpredictability amid the escalating trade war between the US and China, container carriers performed better in 2Q19 than in 2Q18. Nonetheless, clouds of uncertainty have been hovering around the industry as spot rates continue to decline on major East-West trades notwithstanding better capacity management by carriers. On a positive note, some front-loading surge on China-US trade to beat the latest 15% levy on Chinese imports and stock up earlier than usual for Thanksgiving and Christmas sales could boost Transpacific trade and freight rates.
- Port operators: Slow pace of throughput recovery amid the US-China trade war and a slowing global trade spells a worrying trend for port operators. Our Drewry Port Index fell steeply as markets count the cost of the impact of the global slowdown which is gripping major economies. As such, the sector profitability nosedived (ex the IFRS16 impact) and margins have all but stayed flat. We believe the valuations are under correction against the backdrop of the outlook of dampening volume growth.
- Dry bulk shipping: 2019 was expected to be the year of recovery for the dry bulk shipping sector. The macroeconomic factors and natural calamities, however, failed to provide for that recovery. The first five months saw subdued movement in the representative Baltic Dry Index (BDI), and it struggled to cross the 1200 mark, which it had at the beginning of 2019. However, Vale’s comeback triggered the demand side as industries restocked their depleted inventories. The IMO regulations hit the supply side, with increased demolitions and extended dry-dockings. The net effect drove the BDI to a nine-year high in August. The stock prices have been a little slow to respond, with an average YTD gain of about 20%. As compared with 3Q19, however, the 4Q19 is expected to see some correction in terms of rates and thus stock prices, primarily due to seasonal weakness.
- LNG shipping: Low LNG prices and the ongoing US-China trade war continue to weigh on LNG shipping stock prices despite a recent surge in the LNG shipping spot rates. The LNG shipping spot rates have surged with the onset of winter, the use of LNG carriers for storage and some LNG vessels being affected by the US sanctions on Cosco’s tanker subsidiaries. We expect 60% slippage of LNG liquefaction projects from 2018 to 2019.
- LPG shipping: In the LPG shipping space, the Baltic LPG Index is currently trading over USD 80, closing at USD 81.14 per tonne on 11 October, 2019. This is highest in four years despite the limited fixing activity out of the Middle East. Meanwhile, the drone attacks on Saudi Arabia’s oil facility on 14 September led to supply disruptions in the market. We believe despite the crisis, LPG demand should remain strong in Asia. In addition, congestion at US ports, deferment of cargoes in the Middle East and strong winter demand are also key tailwinds for the LPG sector.
- Crude tanker shipping: The outlook for the crude tanker market is positive for 4Q19 and 2020 despite heightened risks in the form of geopolitical tensions and the US-China trade war. Although the sector was expected to recover in 4Q19 with the increase in refinery runs on account of seasonal firmness in oil demand and surge in diesel demand ahead of the implementation of the upcoming IMO regulation on bunker fuel, the recent supply shock because of the US sanctions on Cosco subsidiaries added fuel to the fire.
- Product tanker shipping: The product tanker spot charter rates have increased steeply in the last one month on account of the US sanctions on Cosco’s tanker subsidiaries and the onset of winter demand. The earnings of product tanker companies have benefited from improved spot charter rates in 1H19. The orderbook-to-fleet ratio dropped from 9.4% at end-2018 to 8.1% in September 2019.
Upbeat quarterly earnings from some of the US corporate heavyweights and a new Brexit deal agreed between PM Boris Johnson and the European Union brought plenty of cheer to the stock markets last week. But not to oil.
The oil market is fixated on the world’s growth story, which had only more disappointing news in macroeconomic data as well as on the US-China trade war front.
We are bearish. We expect Brent to remain capped around $60/barrel. Any gains beyond that level in the benchmark are likely to be modest and fleeting, in our view.