Commencing the Quarter – Q3’23

Amid a Consumer Landscape that Appears to Be Weakening with Conditions Resembling a Rolling Recession, Companies Are Implementing Promotions and Optimizing Operations for a Projected Late ‘24/Early ‘25 Rebound; Executives Keeping a Watchful Eye on the Potential for Cascading Effects of Union Strikes and Impact from Student Loan Payment Resumptions

• RPM International (FY Q1’24 – $12.6B, Basic Materials, Specialty Chemicals): “It feels like we’re going through a rolling recession, and the housing market has taken it on the chin. You can see it in companies that serve residential construction and/or the components that go into that, furniture, and other things. Retail takeaway has not been very strong across many categories, and as we commented in the second half of last year, point-of-sale in our categories tended to be mid to high negative single-digits. We’re seeing that improve, which means it’s less bad. And so, I’m hopeful that there’ll be somewhat of a soft landing in the sense that this is a rolling recession.”
•  Jabil (FY Q4’23 – $18.2B, Technology, Electronic Components): “We’re seeing a lot of uncertainty in our fiscal 2024. And the industry is looking at the back half of calendar 2024 for a rebound. In terms of the investment, we’re well aware of the CHIPS Act and then the other investment Acts in Europe, and we are also well positioned in some of the regional trends that are going on both on the manufacturing and the components to go into the semi-capital equipment. We’re really using this period to optimize our footprint, optimize our capability and our capacity in the right regions to support what we see as where the bounce back will happen when it does late in 2024 or early 2025.”
• United Natural Foods (FY Q4’23 – $0.9B, Consumer Defensive, Food Distribution): “As we look forward and we see units continuing to be soft, the consumer to be stressed, and inflation now returning to lower levels, we definitely expect consumer products companies to start promoting more. They’ll need to in order to drive sales. The out-of-pattern high number of price events have returned back to normal levels.”
• Lamb Weston Holdings (FY Q1’24 – $12.2B, Consumer Defensive, Packaged Foods): “We suspect that restaurant traffic trends will be volatile in the near-term as high interest rates, high inflation, and uncertainty continues to affect consumers.”
• Acuity Brands (FY Q4’23 – $5.6B, Industrials, Electrical Equipment & Parts): “Our assumptions aren’t relying on significant improvement from a macro environment. We have returned to a more normal relationship between order intake and shipment rates, so we’re comfortable executing in this environment. What we are ultimately suggesting for fiscal 2024 is that, by the back half of the year, we end up clearing all the legacy impacts of the increased backlogs and all the other supply chain things.”

United Auto Workers Strike

• H.B. Fuller (FY Q3’23 – $3.8B, Basic Materials, Specialty Chemicals): “Only ~1% of H.B. Fuller’s total sales are made to the big three automakers or suppliers of various one, two, or three suppliers. With that said, it’s an important market for us. We’re in the automotive space much more prevalent in the EV vehicle market, which is growing much faster. So certainly, we’re watching that market closely, the big three and what develops there.”
• Cintas (FY Q1’24 – $52.5B, Industrials, Specialty Business Services): “We’re certainly watching what’s going on with the auto workers strike, but we have a very broad-based customer base. And as a result of that, it’s not affecting us to any material degree whatsoever. And keeping in mind that we have no one customer that’s greater than 1% of our revenue and no sector that’s greater than 10%. So that helps us and insulates us a bit from all that.”
• CarMax (FY Q2’24 – $10.9B, Consumer Cyclical, Auto & Truck Dealerships): “It’s a little too early to know exactly what the precise impact of those strikes are going to be. Obviously, we’re closely monitoring the situation to try to identify downstream impacts of the vehicle supply, pricing, and parts…a lot of that’s going to depend on how long the strike goes on.”
• Worthington Industries (FY Q1’24 – $3.1B, Industrials, Metal Fabrication): “We’ve seen little impact to our business given the scope of the strike has been limited and it’s been a short period of time. We recognize that there’s risk associated with the strike, but there’s also opportunities for us. If the strike expands, our facilities have playbooks that will address volume slowdowns. Our commercial and supply chain teams do an excellent job helping our customers navigate all the moving parts that occur when a supply chain suddenly stops. And, more importantly, when that supply chain suddenly turns back on, customers absolutely remember which suppliers did the best job helping them navigate through these tough situations.”

Student Loans

• Victoria’s Secret (FY Q2’23 – $1.2B, Consumer Cyclical, Apparel Retail): “Whenever people talk about student debt and student loan repayments, and which is the brand that they talk about as being most impacted, it’s always us. The belief out there is that times are going to be really tough in the back half and into next year and that probably we’re going to be more impacted than others because we target a relatively young consumer in Gen Z and young Millennials, and [there’s] nothing I can do about that.”
• United Natural Foods (FY Q4’23 – $0.9B, Consumer Defensive, Food Distribution): “When you look at our retail business which is about 10% of our business, we have an extraordinary brand franchise in Cub, which is the market leader in the Twin Cities area…a typical U.S. market, it’s prone to all the challenges that we see across the country, reducing federal assistance, student loans coming back; there’s plenty of pressure on the consumer. There’s also a significant amount of price competition in the market and we’re seeing that.”

Some Highlight Recent Consumer Softness as “Episodic” or “Temporary”, While Others Point to Stretched Dollars and Clear Demand Depression Following Destocking

• Conagra Brands (FY Q1’24 – $12.7B, Consumer Defensive, Packaged Foods): “The timetable for volume recovery has been elongated across the industry due to near-term consumer behavior changes. After three years of unprecedented inflation, along with other macro dynamics, consumers have felt increased financial pressure and used a variety of strategies to stretch their balance sheet. This resulted in a near-term reprioritization of their typical purchase behaviors in order to make their budgets work. We’ve seen shifts like this before and expect these near-term changes in behavior to also be temporary. In fact, recent trends suggest this is already underway.”
• Worthington Industries (FY Q1’24 – $3.1B, Industrials, Metal Fabrication): “We believe that the demand moderation that we’ve seen is a little episodic. You don’t need a home equity line of credit to afford what we have. We have seen some softness throughout retail and certainly throughout the outdoor category. So, we’re not immune to some of those things, but we believe our value proposition is awfully good. And heading into late 2023 and early 2024, we feel much better about volumes returning to some more normal patterns.”
• PepsiCo (FY Q3’23 – $217.4B, Consumer Defensive, Beverages): “We see the consumer right now being more selective. You see some trade-down in terms of channels. You see some orientation toward value. At the same time, the things that I usually look at with the consumer to detect whether there’s high stress, we see good results in. Number one is the convenience store channel. Typically, when gas prices are up and consumer incomes are stressed, you see revenue in those channels under stress as well. For Q3, we saw revenue up 5% in beverages and 8% in foods in the convenience channel.”
• Acuity Brands (FY Q4’23 – $5.6B, Industrials, Electrical Equipment & Parts): “Obviously, we’ve burned through backlog through the first half of our fiscal 2023. We talked extensively through the remainder of the year at how lead times have compressed and that’s led to the destocking you referred to. We’re now getting to a more normal relationship between order rate and shipment rate. So, what we are experiencing now are macro lighting trends. And unfortunately, we’re in a period where people are just buying less lighting and lighting controls.”

Costs Show Signs of Moderating, including Raw Materials in General, though Labor Expenses Remain Elevated

• RPM International (FY Q1’24 – $12.6B, Basic Materials, Specialty Chemicals): “We’ve been fighting a commodity cycle that’s bigger than any of us have ever seen…while raw material inflation is abating and our related price increases are stepping down, labor is still an issue. Items like insurance are a meaningful issue in terms of higher inflation. So, inflation still exists in a number of factors and inflation still exists because of interest rates in the housing market.”
• H.B. Fuller (FY Q3’23 – $3.8B, Basic Materials, Specialty Chemicals): “Regarding the price to raw materials balance, it’s been very consistent this year in this $40M to $45M benefit each quarter. Now, it’s flipped between being more of a benefit from pricing to more of a benefit from raw materials. But we’ll carry that over next year.”
• Lamb Weston Holdings (FY Q1’24 – $12.2B, Consumer Defensive, Packaged Foods): “Input costs continue to increase mid to high single digits on a per pound basis. The increases were largely driven by a 20% increase in the contracted price for potatoes [and] continued increases in the cost of labor, energy, and ingredients for batter coatings. The increase was partially offset by supply chain productivity savings, lower costs for edible oils, and lower freight costs.”
• Cintas (FY Q1’24 – $52.5B, Industrials, Specialty Business Services): “What we’re seeing from an input cost standpoint, labor is still higher than historically. As for other input costs, energy was down YoY. That is really a Q1 subject because if you recall last year, the price at the pump was very high… And then last, material costs. Our global supply chain team is doing one heck of a job in trying to make sure that we’re well-positioned to have very competitive prices and access to all that product.”
• Constellation Brands (FY Q2’24 – $42.0, Consumer Defensive, Beverages): “In the second half of the year, we’re going to continue to face inflationary pressures that we’ve had all year long. We are seeing some easing in inflation, as expected, as we’ve gone through the year. Unfortunately, while we’ve seen some improvement in inflation, we’ve also seen a strengthening peso hold up.”

In Line with our Q3’23 Inside The Buy-Side® Earnings Primer® Findings, Companies Prioritize Debt Reduction; the Prospect of M&A is Largely Dismissed for Now, But Some Hint Toward Increased Activity in 2024

• AZZ (FY Q2’24 – $1.2B, Industrials, Specialty Business Services): “As interest expense continues to be a headwind versus our budgets, we remain committed to reducing debt and consequently are not actively pursuing acquisitions for the remainder of this fiscal year.”
• Conagra Brands (FY Q1’24 – $12.7B, Consumer Defensive, Packaged Foods): “Our top priority is delivering. The importance of having a clean balance sheet in the current strained external macro environment is very important to our investors, our ratings agencies, and that is our top priority. When the time comes that we’ve got our balance sheet where we want it to be, M&A has always been part of it.”
• McCormick (FY Q3’23 – $16.0B, Consumer Defensive, Packaged Foods): “We’re going to deliver faster than we thought to get back to our 3.0x target. As we get into next year, as we get closer to our targets, as assets come up that are attractive…we’re getting back to where we want to be to enter back in the M&A market and as long as it meets those strategies in both Consumer and Flavor Solutions for attractive assets, we’ll be buyers hopefully at the right price.”
• Progress Software (FY Q3’23 – $2.3B, Technology, Software – Application): “While infrastructure software valuations remain somewhat high…our corporate development team continues to vet a very encouraging pipeline of targets. In the meantime, we continue to focus on integrating [our recent acquisition], paying down debt, and maintaining adequate financing as we look for the next deal.”
• RPM International (FY Q1’24 – $12.6B, Basic Materials, Specialty Chemicals): “As we sit here today, the M&A market is relatively slow. We will continue to execute on good, strategic, small to medium-size deals. But the days of huge multiples, in my opinion, are over, if not forever, at least temporarily. We went through a period of time where incremental cost of capital was almost zero. That is not true today. And so, given the choppiness in the markets we are focusing a lot of time and attention on driving organic growth where we can. It’s easier said than done in an economic environment that feels like a rolling recession, both geographically and across sectors.”

China Exhibits Emerging Green Shoots Albeit Off a Low Base, While Europe Garners Mixed Perspectives

China

• Lamb Weston Holdings (FY Q1’24 – $12.2B, Consumer Defensive, Packaged Foods): “China restaurant traffic growth was very strong but off depressed levels as the country rebounded from severe COVID-related restrictions.”
• H.B. Fuller (FY Q3’23 – $3.8B, Basic Materials, Specialty Chemicals): “We’re seeing strong performance in China. In fact, when you look at China from Q1 to Q3, our volume has swung from a negative 15% roughly to a positive. So I give the team and China a lot of credit to be nimble enough to handle operationally that shift in volume.”
• McCormick (FY Q3’23 – $16.0B, Consumer Defensive, Packaged Foods): “This is really an economy that is recovering more slowly than what we would have expected…people are simply not going out to a lot of the catering and outside dining events that we’ve seen in the past, and that’s just been a slower recovery overall. We’re also seeing that happen in retail. Consumer spending is just soft right now overall in China, and we’re seeing that play out…but the fundamentals that drive that business are still there, and it’s just going to take a little bit more time to get back to what we expect from this part of our business.”

Europe

• TD SYNNEX (FY Q3’23 – $8.7B, Technology, Electronics & Computer Distribution): “As we came through the first half of the year, we had talked about Europe being stronger than anticipated. We all knew of the headwinds that they had faced in Europe and Europe was performing better on the top-line than the Americas. We had seen a change in that cycle, if you will, in the third quarter, where Europe began to look a lot like the Americas looked like in the first half.”
• Commercial Metals (FY Q4’23 – $5.1B, Basic Materials, Steel): “I’ll now turn to Europe where market conditions are challenging. Sluggish demand and excess supply have combined to put pressure on pricing and compressed margins. General economic uncertainty continues to negatively impact sentiment and activity levels across our key end markets. Additionally, high interest rates, despite recent central bank easing, remain an overhang to the Polish residential construction sector.”
• RPM International (FY Q1’24 – $12.6B, Basic Materials, Specialty Chemicals): “Europe went in early. We’re now seeing better performances in Europe. There’s more stability around the impact of the Russian war on Ukraine. We’re rounding easier comps. And quite candidly, there is some reasonable growth in the UK, for instance. And the UK seems to be performing better than Continental Europe as we sit here, and for us, that’s a good thing, because a little less than