A combination of societal mood and the raw facts emanating from the presentations of 60 CEO’s which we have just met at a US investment conference catalysed an unusual discomfort for me. It was something I have not felt during my previous US visits.
They brought to mind lyrics from Bob Dylan’s great song The Times They Are A-Changin:
“Come mothers and fathers throughout the land
And don’t criticize what you can’t understand
Your sons and your daughters are beyond your command
Your old road is rapidly agin’…
For the times they are a-changin’.”
There were common themes that weaved their way into many of the CEOs’ presentations. We cover three in detail below, but there were others:
• Inflation is persistent, structural and toxic to businesses with thin gross margins
• Many are concerned about a hard landing
• There are ideological fissures between business and the Biden administration
• Financial firms are arguing that they are well prepared for any financial crisis
• A mismanaged green economy transition is forcing us back into hydrocarbons
The three most notable themes, however, were these:
Great management teams blind-sided by demand shifts
Walmart, the US’s largest retailer with over 230 million global customers reported results from the first quarter of its 2023 financial year on 17 May. Consolidated operating income fell 23% versus the first quarter last year, caused by higher input costs and demand shifts as consumers moved from higher margin merchandise to lower margin necessities such as food. CEO Doug McMillon described the operating environment as ‘unusual’ and the poor profit performance as ‘unexpected’.
Throughout its 2021 financial year, Amazon was enjoying insatiable demand but struggling to fill orders due to labour shortages. So it doubled the size of its workforce during the pandemic. It also increased physical capacity at its fulfillment centres. But Amazon’s Covid demand boom came to a shuddering halt in 2022 (the first quarter of its 2023 financial year). Net sales for Amazon’s online store ‘unexpectedly’ declined 3% year-over-year versus the first quarter of last year. CFO Brian Olsavsky best summed it up on Amazon’s earnings call: ‘The issue has switched from disruption to productivity losses, to overcapacity on labour’.
To prove the point, Target issued two profit warnings within the last four weeks. The reason is shifts in product demand from consumers.
A culture of work reluctance and rising wage inflation
An ill-tempered James Foot, CEO of CSX Corporation (one of North America’s leading rail transport suppliers) lamented at the conference that his 40 years of railroad experience ill-prepared him for a pandemic.
Mr. Foot’s disquiet is due to his mid-2020 decision, during the height of Covid, to lay-off staff arguing that CSX’s customers’ businesses had stalled, reducing rail demand. What Mr. Foot could not and did not know was that consumer demand for goods would subsequently skyrocket as lockdowns starved consumers from spending on services.
CSX experiences a natural labour attrition rate of 7% a year. Since Covid, this has risen to 10%. But the real problem is that the company is struggling to find hires. In Foot’s own words: ‘In 2020, due to extreme stress, I laid off employees and now they don’t want to come back’. The result has been a collapse in rail service levels and congressional hearings with CSX in the eye of the storm. Most CEOs complained that their greatest challenge is sourcing labour.
The next big opportunity is in infrastructure
In 2021, the American Society for Civil Engineers gave the US a score of C-minus for infrastructure. It warned that 43% of roads were in mediocre condition. Their assessment was no better for bridges on the interstate highway system, constructed during the Eisenhower administration, which are nearing the end of their useful lives. Infrastructure disrepair is most severe in those places outside the voters’ view – tunnels, rail lines, dams, water, and electricity systems.
The requirement for infrastructural renewal is not in question. The political appetite to fund less sexy and less visible projects is. In addition, there is a labour shortage. The American Welding Society estimates that the US will be short of 400,000 welders by 2024. The average age of a welder is currently fifty-five. The National Homebuilders’ Association Spring 2021 Market Report found the US requires double its current number of plumbers, and the US Bureau of Labour Statistics estimates that 7,000 electricians join the field annually while 10,000 retire.
CEOs presenting at the conference whose businesses manage large-scale infrastructure projects were upbeat – they are waiting for a big pay day. And each day that passes, the odds are stacking in their favour!
We are witnessing tectonic societal shifts, which we believe will have meaningful implications for financial markets. Under-appreciating and miscalculating these could have dire consequences for investors’ capital.