Weekend Update #84
Welcome to Blue Room's Weekend Update. Each week, we're sharing what companies we're researching and the what, the who and the how that we think makes the companies interesting and unique. This roundup is brought to you weekly by a group of interns, creative minds, artists and investors who believe that through best in class investing along with the democratization of financial education we can do great things together. Enjoy, Explore and Share.
As investors traversed the second week of earnings season under the shadowing curtain of rising unemployment rates, record housing prices, and the persistent threat of recession, the U.S. stock market posted noticeable gains through the first four trading sessions before cooling to end the period. The S&P 500 closed the week at 3,961.63 (+2.55%), the Dow Jones Industrial Average closed at 31,899.29 (+1.95%), and the Nasdaq Composite closed at 11,834.11 (+3.33%).
Earnings from headlining companies such as Netflix, Tesla, and Snap Inc. highlighted the turbulent and uncertain economic conditions of the times, contributing to reactionary market swings centered around questions of strength in supply chains and digital advertising services. In a stark transition of policy, the European Central Bank raised interest rates by a half-percentage point, representing the first rate increase from the central bank since 2011 and an end to the ECB's long-persisting negative rate.
In the spotlight of recent economic reports came heightened unemployment numbers from the Department of Labor, with initial unemployment claims growing by 7,000 to 251,000, topping median estimates of 240,000 claims and bringing filings for unemployment insurance to their highest level since November 2021. The Federal Reserve Bank of Philadelphia released their Current and Future General Activity indices this week as well, with the current metric falling for the fourth consecutive month to -12.3 and the future index reaching a 42-year low of -18.6. Likewise, responses to the Manufacturing Business Outlook survey suggest overall declines in regional manufacturing this month and expectations of declines over the next half-year.
The coming week will prove a pivotal test for the U.S. stock market and overall economy as a whole, with earnings results from industry leaders such as Alphabet, Meta Platforms, Amazon, and Apple, Gross Domestic Product results, and commentary from the FOMC and Fed Chair Powell all scheduled over the coming seven days.
Thank you Blue Room Fellow AIDAN FETTERLY
“Those who cannot remember the past are condemned to repeat it.”
— George Santayana, The Life of Reason, 1905
The Federal Reserve has made it clear that its current priority is maintaining price stability — half of its dual mandate, along with ensuring maximum employment. The U.S. central bank will do so by raising interest rates enough to cool inflation back down to 2% from the 9.1% year-over-year CPI print in June. After scrutinizing the shortcomings of monetary policy that led to the prolonged inflation in the 1970s and 80s, the Federal Reserve knows it must do everything in its power to avoid repeating such a scenario. The Fed has clearly kept these lessons top of mind.
But what exactly were the factors that led to such persistent inflation back then? There were supply chain shocks due to an energy crisis, a wage-price spiral, and inflationary psychology among consumers.
Although the American population and financial markets have gained confidence that our central bank has the knowledge and power to keep our economy in balance, there is evidence that these key ingredients for an inflationary spiral have already developed, and the key question is how persistent these effects could be.
SUMMARY
Netflix reported better than expected membership numbers, reporting a loss of only 970,000 compared to its guidance of 2 million, while earning $7.95 billion in revenue, a miss on expectations of $8.04 billion. The beat on subscriber numbers relieved investors, despite the company missing on revenue, as many anticipated a worst case scenario after a big negative surprise in Q1. Executives attributed the better results to a stronger content slate, particularly the release of Stranger Things Season 4, along with a stronger seasonal period.
Netflix is hoping for a better second half of the year as elevated churn due to price hikes returns to more normal levels and an even stronger content slate with the second part of Stranger Things 4 and big budget film The Gray Man releasing in Q3. The company has guided to 1 million net adds for next quarter. Netflix continues to make progress on its paid sharing strategy, and launched a campaign in five different Latin countries which give members the option to add a household to their plan for an additional $2.99. The company hopes this strategy will either increase the average revenue per membership, or encourage users to sign up for their own plan.
Still, headwinds remain for the company due to increased competition and a number of economic factors which are likely to remain throughout the rest of 2022. A higher-than-expected impact from foreign exchange reduced the company’s top line revenue by roughly 4%, causing Netflix to miss its guidance as the Fed continues to hike interest rates, causing a strengthening of the US Dollar. Now with clearer expectations of these headwinds, Netflix has guided to $7.8 billion in revenue for Q3, a sequential decline. As a result of the uncertainty, the company is aiming to keep its cash spend on content stable at roughly $17 billion annually for the next couple of years, as well as maintain 19-20% operating margins until revenue shows signs of reaccelerating.
A large focus of the earnings call was regarding Netflix’s ad-tier launch, which the company is now targeting for early 2023. Through the company’s partnership with Microsoft, Netflix is looking to take a slower, iterative approach than originally anticipated which is likely to delay advertising revenue and reduce subscriber acquisition potential in the near-term. The company is also not expecting to roll out its paid sharing strategy globally until next year, which also reduces the near term outlook for subscriber growth and monetization.
Overall, the company has done well to manage its financials, but developments in paid sharing and advertising will be the main growth drivers for the company moving forward, especially in highly saturated regions like the US. Intense competition continues to be the main concern for Netflix, so executing on these two catalysts will be crucial for the company’s long-term success.
SUMMARY
Tesla performed well on earnings despite a challenging quarter with a sequential decline on deliveries. Higher ASPs allowed the company to mitigate some increased costs from inflation and production inefficiencies which contributed to an overall lower gross profit margin. Looking to the second half of the year, executives indicated that increased material costs should not have as much of an impact as previous quarters since many commodity prices are starting to level off or even trend down. Startup costs in Berlin and Austin are also likely to continue trending down as both factories continue to ramp and become more efficient.
Tesla achieved record production in June for both its Fremont and Shanghai Gigafactories, and the company believes it has the potential to have a record breaking second half, barring any unforeseen external forces such as additional supply chain issues or COVID lockdowns. It also reached 1000 vehicles/week in June for its Berlin Gigafactory, a new milestone as it continues its production ramp. By year end, Tesla is aiming to produce 5,000/week for both Austin and Berlin, with the potential to reach 10,000/week by the end of 2023.
The company also indicated that while its 4680 battery packs are more likely to have a larger impact in 2023, Tesla has enough 2170 cells to achieve all production needs throughout the rest of the year. As a result, executives are estimating they can exit the year with roughly 40,000/week which sets the EV manufacturer up for roughly 50% growth in deliveries for 2022.
Looking to 2023, production and deliveries look even stronger with the addition of the Cybertruck which is still on schedule for production in mid-2023.
Other segments of the business performed well as the Energy business made meaningful progress in Q2, achieving higher volumes with stronger unit economics resulting in an overall record gross profit. Services and Other business returned to positive gross margin with growth in merchandise, Tesla-owned collision centers and related services. The used car business remains strong, particularly as interest in electric vehicles expands.
Tesla has deployed FSD beta with city streets driving capability to over 100,000 owners, and plans to release FSD beta to all North American customers by end of this year with Europe and other regions to follow, depending on regulatory approval. The company plans to increase the price of FSD sometime by the end of this year after the launch of its Y beta, and Elon Musk believes they are close to “solving” Full Self Driving in 2022. The company is hosting its AI Day in September where it is likely to showcase exciting progress on its current projects as well as potentially new ventures.
On Friday, July 15, President Biden met with Saudi Crown Prince Mohammed bin Salman in an attempt to increase global oil production as gas prices continue to overwhelm American – and global – consumers. Despite President Biden remarking late Friday that Saudi officials shared his “urgency” to increase the supply of oil and that he expects “further steps in the coming weeks,” Saudi ministers insisted that any policy decisions will be made by OPEC+. It is necessary to note that OPEC+ is a consortium of countries that includes Russia. The next OPEC+ meeting is scheduled for August 3.
What’s more, even if Saudi Arabia were willing to increase their production of oil, it is unlikely that it would be able to lift production as much as people had hoped. People familiar with its pumping ability have claimed that Saudi Arabia has limited additional capacity to ramp up production. Saudi Arabia has long been thought of as one of the most flexible OPEC members in the sense that it is capable of boosting output from its vast reserves while also willing to reduce production as necessary to prop up falling oil prices. Only a few other members of the oligopoly have space capacity, including UAE and Kuwait, but their extra pumping capacity pales in comparison to that of Saudi Arabia. Saudi Arabia has said its production capacity is at roughly 12 million barrels a day.
Saudi Arabia is currently producing about 10.5 million barrels a day, meaning it could potentially increase output by another 1.5 million barrels per day. However, people familiar with Saudi Arabia’s current operations say that they would struggle to produce 11 million barrels a day for more than a few months, and could not sustain 12 million barrels a day for more than a few weeks. Even if Saudi Arabia decided to increase production, a sustainable marginal increase in production would likely amount to only an additional 0.5 million barrels per day. But this increase does not fit into the short-term plan that the country has developed for the next five years. Saudi Arabia has plans to raise output capacity to 13 million barrels a day by 2027, but most of this increase will come later down the line. Prince Mohommed bin Salman stated on Saturday that the level of 13 million barrels a day represents Saudi Arabia’s maximum production level; the country has no capacity to increase production past 13 million barrels a day. Indeed, Saudi Arabia does not plan to reach this level in the near term as it must develop the infrastructure to do so. Looking to the short-term, it only plans to increase production by 25,000 barrels a day in 2024 – which would keep net production at roughly 10.5 million barrels per day.
Q2 2022 Earnings Expectations (from Bloomberg):
Adjusted EPS: $(0.04)
GAAP EPS: $(0.21)
Revenue: $1.144 billion (+16% year-over-year)
Net Loss: $(333.517) million (compared to $(151.7) million in Q2 2021)
Adjusted EBITDA: $0.194 million (compared to $117.4 million in Q2 2021)
Avg. Revenue Per User (ARPU): $3.37 (+17% year-over-year)
Daily Active Users (DAUs): 344 million (+1% year-over-year)
Q2 2022 Performance:
Adjusted EPS: $(0.02)
GAAP EPS: $(0.26)
Revenue: $1.111 billion (+13% year-over-year)
Net Loss: $(422.067) million (compared to $(151.7) million in Q2 2021)
Adjusted EBITDA: $7.190 million (compared to $117.4 million in Q2 2021)
Free Cash Flow: $(147.451) million
Avg. Revenue Per User (ARPU): $3.20 (+% year-over-year)
North America: $7.93 (+7% year-over-year)
Europe: $1.98 (+1% year-over-year)
Rest of World: $0.96 (-10% year-over-year)
Daily Active Users (DAUs): 347 million (+18% year-over-year)
Cash, cash equivalents, and marketable securities: $4.9 billion
HIGHLIGHTS:Total time spent watching Spotlight content grew 59% year-over-year
The daily average number of Snapchatters aged 25 and older engaging with shows and publisher content increased by more than 40% year-over-year
Amidst the Federal Reserve’s rate increases, spurred by growing concern over inflation, investors seeking refuge from market volatility have been swarming to the dollar. The world’s reserve currency has since reached a near-decade high in the first half of 2022, and its seemingly persistent strength has been reflective of both tighter monetary policy and lower global risk tolerance.
But what does the strength of the dollar mean for Royal Gold — a company whose revenues are directly tied to the price of gold? Historically, gold is inversely related to the strength of the US dollar. This correlation can be observed since January, as the spot price of gold has declined ~3.5% YTD, while the US Dollar Index (DXY) has risen ~12% YTD. Accordingly, near-term outlooks for any company whose earnings are predicated on the value of gold seem somewhat bleak as the dollar continues to march upward amidst rate hikes and growing concerns of market chaos.
Over the long term, however, Royal Gold’s outlook could potentially benefit from a period of repressed gold prices and a strengthened US dollar, specifically before a potential economic downturn.
Congratulations to Blue Room Housing President SHARON SCHNEIDER for releasing her book "Handbook for an Integrated Life: A practical Guide to Aligning Your Everyday Choices with Your Internal Compass".
We couldn’t be more excited about your accomplishment and future book success!
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