We’ve been hearing the song for months now. Between rising costs and outright shortages of everything from labor to spare parts, corporate executives are nervous about defending their profit margins.
Some global conglomerates are expanding fast enough to keep raising the bottom line even if margins contract. They’re able to support their stocks and maybe even continue their post-pandemic rally.
Others, notably consumer product manufacturers and retailers, have a much harder choice on the horizon. They can either swallow rising costs and watch their earnings stall . . . or they can raise prices and watch competitors take their customers.
It’s not a great choice. In a lot of ways, it reminds me of the choice that now confronts the Fed.
The Fed can either swallow inflation in order to keep interest rates low . . . or start tightening, even if it means making Wall Street very unhappy.
However, it isn’t necessarily an all-or-nothing choice for anyone. Yes, inflation is real. And yes, raising prices (or interest rates) will sting.
But one of these options is still better than the other.
CEOs Are Paying Attention
The Fed has absolute control over short-term interest rates. While they can squander that power or let themselves be swayed by external considerations (like shielding the economy from the impact of universal lockdown), they can take comfort knowing it’s their decision.
Likewise, corporate executives set their own prices in order to capture the market share they want. Nobody is forcing them to swallow inflation.
And every company is different. Some want to chase larger markets and will abstain from raising prices in order to win customers . . . even if it means sacrificing profit in the here and now.
Think of Amazon reinvesting vast amounts of money from time to time to conquer new retail categories or even invent entire business lines like cloud computing. Think of Microsoft. Think of Facebook and its “metaverse.”
Others are happy with their presence or even secure with their customers’ loyalty. They won’t cut prices. Think of Apple, serene among its fans and letting Samsung and other phone makers fight over scraps.
Guess what? That’s how life always is in Corporate America. Every CEO has a strategy. They pick their spots based on their deep knowledge of their business and what their competitors are doing.
There are winners and there are losers. Losers pivot. Winners keep winning until the tide turns against them . . . then they need to pivot, too.
What’s constant is that they control what they can and use that control to work around what they can’t. They can’t control inflation. Costs are rising.
But they can control the prices they charge their own customers. If they raise prices, cost increases become the customer’s problem.
They can all raise prices and protect their margins. It’s called discipline. We see it a lot in commodity industries where producers agree not to undercut each other in order to avoid an expensive (or even lethal) competitive race to zero.
In that scenario, guess what? Margins are preserved and earnings growth trends continue roughly on their projected track. The ultimate consumer — you and me — takes the brunt of it in the end, but if we can negotiate higher salaries in the process, the cycle can continue.
That cycle is called wealth generation, by the way. A healthy economy generates roughly as much inflation every year as it expands. Inflation is growth at a basic level.
When technology unlocks ways to do less with more, we also become more productive. Inflation lags economic growth. What’s left is newly created wealth.
And that’s a good thing.
Supply Shock, Not Sticker Shock
Besides, corporate executives aren’t passively complaining about “inflation” as an abstract threat. What they’re actually seeing and talking about is strains in their supply chains.
There isn’t enough labor right now to run a lot of restaurants. There aren’t enough truckers to haul gasoline from the refinery to the filling station.
There aren’t enough semiconductors to install in all the cars that people want. Factories slowed down in the pandemic and let their stockpiles run out. Now they all need to buy back in at once.
It takes time to fill all the orders. There are backlogs and bottlenecks. But this isn’t really “inflation” as a persistent force of nature. It’s just shortages.
When you can’t get something at all, you need to offer desperation pricing in order to get someone else to part with their supplies. That’s what we’re seeing now.
CEOs aren’t stupid. They rolled with the trade war and rebuilt their supply chains. They’re doing it again right now.
People who can provide supply are staffing up and expanding their capacity. It’s a process. Sooner or later, they’ll have everything up and running.
Shortages will stop. And if demand remains constant, prices will stabilize.
When prices are stable, inflation is low. Corporate leadership will solve the current problem . . . even if the Fed does nothing at all.
Cannabis Corner: The Long View
Another leg down for the cultivators this week, this time thanks to an analyst inaugurating coverage on the group with the same argument I’ve been making for years.
It turns out that there simply aren’t enough Canadians to support the current supply of dried plant product their country produces . . . at least, not for the analysts at Barclays to feel comfortable.
And there aren’t really enough U.S. consumers, either. The map down here in the 50 States has already turned about as green as it gets in terms of population . . . one way or another, most people will find a way to get access if that’s what they want.
That’s the challenge. While sales surged last year in the pandemic, the pool of active consumers didn’t expand that much. This is a stable population, not a viral craze.
We knew all that. But having a top-tier global bank like Barclays spell it out again didn’t exactly drive a lot of fresh buyers to stocks like Canopy and Tilray . . . erasing a lot of the gains we crowed about last week.
One week up, one week down. And by extension, one year up and one year down as Big Weed remains stuck in an extended slump.
If you got into Canopy five years ago, it was with a long-term vision in mind. You’re up close to 60% over that period as the industry slowly moves away from the initial commodity rush toward more differentiated (and profitable) products.
Canopy was the leader back then and is still one of the biggest and best-funded cultivators on the planet. It makes sense that this is where most of the industry’s wealth has been generated.
But the last year has been a real test of shareholder confidence . . . and a nightmare for those who gravitated toward other “green” stocks.
The long-term winner has been Scott Miracle-Gro (SMG), selling hydroponic equipment to all the growers. In hindsight, that’s truly the best bet of all.
And since legal cannabis seems to be here to stay, even if cultivators come and go, it’s probably still going to outperform. While SMG dropped 6% this week along with the rest of the group, shareholders are still up 12% so far this month.
Short-term outperformance like that compounds into more expansive long-term gains. If you’re here for that kind of experience, stick with the established names.
Of course, if you want something more transformative, pick out a diversified basket of next-generation startups and hang on for five years. One or two should do well . . . and you’ll have your thrill.
GreenTech Opportunities: Welcome RIVN
If you’ve been listening to my new weekly radio segments with Kevin McCullough, you know that my team has been eager to see what happens when electric truck designer Rivian (RIVN) goes public.
Wonder no more. We were expecting RIVN to hit Wall Street at around $70. The deal ultimately priced at $78 due to investor demand.
A little over a week later, here we are with the stock closer to $130 as its initial trading range materializes.
RIVN will probably show up in at least one of my portfolios under the right circumstances. For now, however, I want to talk about the way the stock reflects the new EV universe.
It’s a lot more than Tesla now. And we’ve come a long way since Tesla hit the market with a lowly $1.7 billion market cap back in 2010.
Back then, it took Elon Musk six months after the IPO to round up 3,000 people willing to put a deposit down on the first Tesla cars . . . years before they rolled off the assembly line.
Now a lot more people get the idea of a battery vehicle as more than a toy. RIVN has a backlog of 48,000 orders waiting for production to start.
That’s $3.2 billion in future revenue lined up and ready to go. As long as the pipeline stays full, that’s already enough to sustain a company 1/10 the size of Tesla today . . . roughly where Elon Musk’s operation stood at the end of 2014.
If Tesla is fairly valued, then we’d expect Rivian to rate roughly $130 billion in market cap today. Clearly the market is paying attention. While we are also watching, I’d like a better entry point.
But I am not counting this company out. Let Ford find a new partner elsewhere. Rivian doesn’t need to team up with anyone unwilling to fork over a massive premium to buy the company outright.
If anything, Ford is the smaller player right now by Wall Street standards despite its massive cash stockpile, venerable brand and other resources, so the deal would have to go the other way. Wouldn’t that be something to see!