Brendan Caldwell, President and CEO, Caldwell Investment Management
Focus: North American stocks
In a recent comment to markets, the US Federal Reserve signaled its willingness to tolerate a recession – and hopefully moderate – rather than allow high inflation to continue. As a result, higher rates helped push the US into recession in the second quarter of 2022 (technically defined as two consecutive quarters of negative GDP growth). Inflationary pressures from rising wages and other inputs (such as commodity prices and freight rates) have led companies to increase costs that put pressure on consumer spending on a real basis. Spending in “re-opening” categories like travel and entertainment appears strong, but consumers are making trade-offs in other commodity-based categories (such as electronics, furniture, cars, and even everyday household products). This leads investors to wonder what happens to the economy if, or when, growth in service-based categories begins to slow. Additionally, as consumers’ willingness or ability to deal with higher prices wanes, companies’ ability to maintain margins, and thus profits, may come under pressure, in sharp contrast to the strong earnings growth we’ve seen over the past two years.
Given all the uncertainty, it’s no surprise that nine of the 11 segments of the S&P 500 are down year-to-date, with the market down more than 10 percent overall. In terms of our forecasts, predicting the future is very challenging in the best of times and increasingly difficult in current environments. We will continue to focus on identifying high-quality, well-managed companies with a proven history of navigating challenging environments and believe that professional investment advice can be of great value in times like these.
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Costco (COST NASD)
Latest Purchase – July 22, 2022
The leading operator of multi-category retail stores and giant malls; The third largest global retailer with 830 warehouses worldwide serving 64 million households.
Why do we love her? (More specifically, why now?)
- Despite the massive increase in demand for the COVID-19 coronavirus, they are still seeing strong growth and consistent traffic numbers. Renewal rates for new members are trending well ahead of pre-COVID-19 levels indicating that demand may be sustainable at these higher levels.
- COST is a price leader but isn’t as vulnerable to lower-income consumers – they haven’t seen a downside business yet but will likely continue to benefit in that environment.
- Powerful Executive Membership Conversion. After emerging from the pandemic, executive members accounted for 55 percent of paid memberships in the United States and Canada, and 17 percent internationally, highlighting opportunities for long-term membership conversion.
- Executive membership increases customer perseverance and spends more than basic members.
- The price still lags behind competitors in some categories, so COST can withdraw this leverage if necessary without significantly affecting demand. New programs such as grocery delivery also create customer traction. Strong gas sales lead to more visits to in-store attachments. Opportunities for geographical expansion in China.
LKQ (LKQ NASD)
Latest Purchase – July 21, 2022
LKQ is the leading supplier of aftermarket (AM) auto parts in North America and Europe. 20 times bigger than her second competitor in Narcotics Anonymous; 2-3x larger in Europe.
In North America, it sells primarily to large, independent collision repair shops; The business is driven by total vehicle mileage and vehicle safety standards.
- Note that crash shops are LKQ customers but the insurance company ultimately pays for 80-90 percent of the repairs. Given that AM parts are 40-50 percent cheaper than OEM parts, insurance companies are incentivized to use cheaper parts to lower their costs (particularly relevant in an inflationary environment).
- This business should benefit from reopening, return to business, lower gas prices, etc. as mileage remains below 2019 levels.
- Consumers are also more likely to choose repair versus replacement within the next two years. Due to the high prices of new and used cars, the average life of the vehicles supports the repair activity.
- It also sells special parts for trucks, RVs and marine markets – this category is more discretionary.
In Europe, LKQ sells to crash and repair shops with a greater focus on mechanical parts (windshield wipers, belts, air filters) versus collision.
- Regulations passed in the past few years have opened up European markets for non-OEM parts; Europe still catches up with North America in terms of AM segment penetration.
LKQ is undergoing a restructuring aimed at improving profit margins; Targeting sustainable EBITDA margins for the DD segment versus eight percent historically
Electronic Arts (EA NASD)
Latest Purchase – 29 July 2022
Electronic Arts is a leading game developer whose content and services can be played and viewed on consoles, computers, smartphones and tablets.
Its game portfolio includes wholly owned properties – such as Battlefield, The Sims and Apex Legends – and licensed brands such as FIFA, Madden NFL, NHL and Starwars.
Why do we love her?
- The global gaming market is huge and growing well above GDP.
- There are significant barriers to entry due to development costs, and associated customers and licensing arrangements with major sports brand franchises give big developers the upper hand.
- EA’s marketing and R&D base also acts as a competitive advantage against smaller game developers, allowing for faster development schedules.
- The business model has retreated from risk over the years due to strong growth in “live services” revenue; Single game versions have a much smaller impact as the live services account for about 70 percent of total revenue.
- Direct Services are sales of additional content for console, PC and mobile games, licensing of revenue from third-party publishing partners that distribute our games digitally, subscriptions and advertising.
- Engagement with EA games remains strong despite the reopening as games have more of a social aspect than just the individual pursuit many believe – and this is driving growth in active accounts and therefore bookings.
- EA’s relatively recent acquisitions of mobile game studios are helping to drive growth and strengthen EA’s position in a market where it usually lags behind.
- EA is also leveraging the expertise of mobile game studios to roll out mobile versions of its popular franchises such as Battlefield and F1.
Snapshots: Mar 30, 2022
CME Group (CME NASD)
- Then: $241.80
- Now: $200.63
- Yield: -17%
- Total Return: -17%
Quanta Services (PWR NYSE)
- Then: $132.16
- Now: $134.81
- Yield: 2%
- Total return: 2%
Micron Technology (MU NASD)
- Then: $79.16
- Now: $62.66
- Yield: -21%
- Total return: -21%
Average total return: -12%