Weekly Reads - November 13, 2023
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While investor interest in financial stocks is at record lows the largest U.S. banks continue to execute and consolidate market share setting them up as long-term winners in this industry.
The four largest banks took nearly half of all banking profits in the 3rd quarter as the largest banks flexed their growing advantage over smaller banks. Out of 4,400 banks, the top four made 45% of all industry profits, up from 35% a year ago and above the ten-year average of 39%. The driver has undoubtedly been deposits which have stayed stable at the largest banks vs declining at smaller institutions. With little deposit pressure, the banks’ net interest margins have been hit far less than smaller banks who have struggled to retain consumers. Industrywide banking profits fell 5% in the 3rd quarter as profits were dragged down by losses on lending, bond market investments, and a 260% increase in interest costs. The top four banks saw their bottom lines grow 23% on average as consumers have flocked to the perceived safety of these banks after the failure of smaller banks over the last year. The top four haven’t seen the same pressure as smaller banks to increase deposit rates to retain consumers. The top four paid less than 2% on interest-bearing accounts vs 3% for regional banks with 40% of deposit accounts for the top four banks paying no interest at all (30% for the industry overall). This stark difference has led to the top four banks aggressively taking deposit and profit share with regional competitors hobbled and unable to put up a fight in the current environment. Bad loans, weak balance sheets, and higher deposit costs are not going away anytime soon and any more public failures of smaller banks push deposits toward the big banks. While the top four banks are susceptible to rising deposit costs, rising delinquencies, and run-off of consumer savings they remain in a strong position to take advantage of the struggles of regional banks over the next few years. This financial downcycle has shown the strength and brand of the top four banks leading to the biggest migration of deposits in recent history that will continue to drive above-industry earnings growth long-term.
The 2023 Holiday shopping season is looking eerily like 2022 with retailers expected to be saddled with too much inventory forcing massive discounts and dragging profits margins.
It’s shaping up to be an unhappy holiday season for retail with high inventories expected to lead to steep discounts for consumers and lower profit margins. This step up in inventory is coming at the worst time imaginable with shoppers expected to spend just 3% - 4% more this season, the slowest growth in 5 years. According to Reuters two-thirds of 30 major retailers have inventory turnover below peers indicating a slowing of sales or excess stock. This could be déjà vu for retailers who saw excess inventory crush their gross margins last year as consumers paused purchases due to high inflation. This year some of the most prominent retailers like Dollar General, Dollar Tree, Target, Walmart, Ulta Beauty, and Macy’s could be some of the most impacted retailers with current inventory ratios underperforming their respective retail sectors. Aside from inventory problems, boots-on-the-ground research from research firm Jane Hali & Associates reported discounts at Kohl’s and Macy’s were as high as 60% with lower foot traffic than last year. Retailers are seemingly offering larger discounts earlier this holiday season, driven by concerns that consumers may be in a worse financial position by the year's end. While retailers are being more cautious around inventory this holiday season current retail trends are painting a negative picture for short-term retail margins.
Beyond Meat’s death spiral is a great example of how important establishing competitive moats are to the success of companies in nascent industries in which demand and the competitive landscape are in flux.
In July 2019 Beyond Meat achieved its highest stock price in company history reaching nearly $235 per share and a market cap of over $14B as investors cheered plant-based products as an alternative to meat. Today, the company is in dire straits recently reporting its sixth straight quarter of negative sales growth alongside rising debt and weak demand for its products. The stock trades at a little over $7 a share ($470M market cap) and investors have largely abandoned the stock and the plant-based sector in general. The company is now in survival mode reportedly considering exiting challenged product lines in the U.S. including and laying off 19% of its total workforce. In their latest report, TD Cowen painted a pessimistic picture for the company citing a deteriorating financial situation and weak consumption of plant-based products presenting a “going concern risk” for investors. The company has outlined a five-year strategy to turn around the company focusing on headcount reductions, pricing, reducing working capital, prioritizing its faster-growing Europe business, and exiting products such as jerky and regions like China. While these initiatives should improve the company’s financial situation there remain many headwinds including the company’s bloated cost base, oversupply of products from new entrants and incumbents, a public disdain for some ingredients found in the product, and macro pressure on consumer wallets. Beyond Meat products are typically priced above traditional meat products making them non-competitive in terms of pricing which is difficult for consumers to stomach in a worsening macro environment. Beyond Meat competitors JBS, Impossible Foods, and Maple Leaf Foods have also decided to reduce headcount or shutter their plant-based business in response to the current environment. Beyond Meat is the classic story of a high-growth disruptor that lacked the competitive moat to protect itself from the competition and now is struggling to differentiate itself in the industry it once pioneered.