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Are some companies simply better at the "lots of work but no jobs" economy?
07/24/2012 8:30 am EST
We all know what the “plenty of work but no jobs” economy feels like. High unemployment. Discouragingly long job searches for those without jobs. Cuts in services in areas that include public parks, schools, and fire protection.
But this kind of economy has implications for investors too. It tests the ability of every company to cut costs but it doesn’t test every company equally. For some companies it means a loss of business as customers look to cheaper alternatives or switch to competitors better able to deliver goods and services despite cuts to their workforce. For some companies it actually provides a boost in business as what these companies sell helps other companies cut costs.
All you have to do as an investor is figure out which companies fall into which camps.
This state of the economy was summed up by the recent news that Bank of America (BAC) will tell an additional 3,500 workers in coming weeks that they’re being let go. That’s on top of job losses of 3,228 since the end of the first quarter, which brought the job losses since June 30, 2011 to 12,624, according to the company’s second quarter earnings report.
The job losses would be even higher, the company said, some 20,000 since June 30, 2011, except that the company added about 8,000 full-time but temporary workers in this period to work on servicing mortgages. That hiring isn’t especially surprising. For the quarter the bank announced that it faced increased claims from Fannie Mae and other investors on billions in mortgage-backed securities sold to these investors that these investors say were written in violation of underwriting guidelines. Such claims soared in the quarter from $16 billion at the end of March to $22.7 billion.
Bank of America says it “remains in disagreement” with these claims. But any defense is certainly going to eat up the hours of thousands of employees as they look at the paperwork for these mortgages.
What you see at Bank of America, though, is just an extreme example of the vise squeezing many companies—in the United States and elsewhere. Companies feel intense pressure to cut costs—with job cuts often seeming to be the fastest, easiest, and most reliable way to cut costs—at the same time as the actual amount of work the company has to perform isn’t falling and may even be increasing.
The implications for all of us who live in the global economy are painful. More of us will be asked to work harder for the same or less money. More of us will wind up without permanent jobs as companies replace full-time permanent workers with temporary, part-time, or outsourced workers (or consultants.) And some of us will wind up with no jobs at all.
The implications for investors are less painful but still very real. At the simplest level, we all know from our daily lives that firing workers and then demanding the frequently demoralized workers who survive do more—with a smile if it’s a service business—doesn’t work. I’ve been on airline flights recently where I was convinced that a member of the cabin crew was about to snap and kill the next passenger who asked for a blanket. Picking up a car at my last visit to my customary rental car location took twice as long as it used to because there was just one worker bringing cars down the elevator when there used to be two or three. And I’ve stopped counting the times recently when I’ve asked a worker in a grocery or warehouse store where to find something only to be told, “I don’t know. Let me find someone to ask.” At this level we know that customer loyalties are being stressed and long-standing management indifference to workers at some companies is becoming clear to customers.
But that’s only at the simplest level. At slightly more complicated levels we know that some companies are better at navigating this economy than others. We know that some will take market share from competitors because of the way they are positioned in markets. We know that some will even thrive because of this economy. And we know that some are indifferent and will raise or fall based on an entirely different set of criteria.
Let know try to lay out those four groups and give you the names of a few stocks that might fall into each category.
Category 1: Companies that will be better at navigating this economy than others. Think about for a minute: There is a group of companies for whom a part-time and temporary workforce is business as usual. Where systems are already in place so that equipment minimizes the degree to which worker skills and attitudes matter. And where worker expectations are already set to relatively low levels.
I’m talking about that group of companies across many industries that even before the Great Recession already relied upon part-time, temporary workers, and that had built systems that compensate for a relatively unskilled workforce. McDonald’s (MCD) is a name that comes to mind. (McDonald’s is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ ) Contrast the McDonald’s operation with that of a competitor such as Starbucks (SBUX), where the role of the barista is crucial to the costumer’s experience and to the efficient operation of the store. There’s no similar bottleneck at a McDonald’s. Or contrast a McDonald’s to the operation of your average rental car counter with its intricate dance of car types, customer rate classes, and available cars.
If you think of other companies that fall into this category—Chipotle Mexican Grill (CMG), for example, I think you can come up with a list of characteristics that define this category. (Chipotle’s stock got killed on Friday. See my post later today for my take on the company’s quarter and guidance.) One key is that that the company offers a reasonable array of variety—burritos with chicken, beef or port—but within limits that don’t overwhelm employees. (You can’t get an enchilada suiza at Chipotle, for example.) I’d put Southwest Airlines (LUV) in this category—consider the choices at Southwest versus at, say, Delta Air Lines (DAL)—or in Apple’s (AAPL) iPhone business in comparison to, say, the offerings of an Android-based company such as Samsung. (Apple is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ )
Category 2: Companies that can help other companies cut costs—or improve the productivity of other companies in this economy. I think the attractiveness of this proposition in the current economy should be obvious. Companies in this category include Middleby (MIDD), which makes restaurant kitchen equipment which cuts preparation time; Schlumberger (SLB), which produces seismic imaging equipment that cuts field work and speeds data processing; Amazon.com (AMZN), Google (GOOG), VMware (VMW), eBay (EBAY), and Intuit (INTU), which all provide online services that improve the costs and/or efficiency of things from selling goods to paying taxes.
Category 3: Companies that are in the right place—that is the low cost end of a market—at the right time. Contrast the positioning of Infosys (INFO) and Tata Consultancy Services (TCS.IN in Mumbai) in the information technology outsourcing market. In some economies—in past economies—Infosys’s emphasis on high end and high value services was a plus. It enabled the company to reap high margins for sophisticated work for clients in the financial services sector, to take one example. But in this economy Tata Consultancy’s positioning in the more bread and butter segment of this industry where margins are lower has allowed it to keep the bulk of its existing customers and to pitch for business from higher end customers looking to save money on their information technology needs. The lower cost structure that Tata Consultancy Services had to build in order to make its lower margin contracts profitable is now working in the company’s favor as it can sell that lower cost structure up market. A company can be well positioned for this economy even if its products don’t carry the lowest current price because they promise ease of integration with already-owned equipment (IBM (IBM), for example,) or because they promise sizeable savings and lower risk down the road (for example, the newer deep-sea drilling rigs of a company such as Ensco (ESV).) I think I’d put Blackrock (BLK) in this group thanks to its ETF (exchange traded funds) business, which lowers costs for providers of 401(k) plans, but you could make an argument that it belongs in Category 2 since its risk management and assessment business is growing as financial institutions farm out more of that work to cut costs.
Category 4: Companies for whom cost cutting isn’t the big issue. For example, shares of Mexico’s CEMEX (CX) have been climbing recently not because the company has cut costs or because U.S. customers see a chance to save on transportation costs for bulky shipments of cement. Even the gradual recovery of the U.S. construction sector that seems to be taking place isn’t the big driver. No, that role goes to CEMEX’s ability to refinance its debt in order to stretch out the maturity of its huge load of borrowing. Certainly CEMEX’s shift to a mildly positive cash flow has been a factor enabling the company to achieve that goal, but it’s been the move from company on the edge of default to one with big liabilities pushed off into 2014 that has made the difference to the stock. I’d put global commodity stocks in this category as well. The issue for the share price of stocks such as BHP Billiton (BHP) and Freeport McMoRan Copper & Gold (FCX) isn’t capital spending budgets or the rising cost of mining. These stocks will go up if investors conclude that growth in China will bottom in the third quarter. Nothing else matters in the near to mid-term. (Which is why these stocks took a big hit on news reports over the weekend that an advisor to the People’s Bank of China projects that growth in the third quarter will fall to 7.4% from 7.6% in the second quarter.)
The fact that a company and its stock falls into one of these four categories doesn’t mean you should rush out and buy it. Stocks in these categories can be overpriced—Chipotle Mexican Grill certainly was before Friday’s plunge—and they’re subject to the risk-on/risk-off swings that have driven such extraordinary volatility in this market. I think we’re headed to a big risk-off swing on worries about China’s growth and on another turn of the screw in the Greek and Spanish debt crises. Staying on the sidelines until that swing moves to an extreme is certainly a good idea.
But even when that fear abates a bit, the global economy is still going to be a very tough place, and I think the companies that deserve your first look, because they stand the best chance of doing better than okay in this economy, are those that belong to my four categories above.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple, Ensco, Freeport McMoRan Copper & Gold, McDonald’s, Middleby, and Schlumberger as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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