This weekend I experienced sticker shock at the gas pump and then again at the supermarket. Meanwhile, economists fill the airwaves with statements that gas prices at $4 a gallon are the "tipping point" where consumers supposedly alter their buying patterns towards goods and services. Tell that to a single mom on a weekly food budget driving to a minimum-wage job an hour away.
The reality is that with gas prices up almost 17% this year, above $4 a gallon in seven states and only 6.7% below the July 2008 high, it's akin to bombs detonating at timed intervals in the economy. By that I mean the first row of explosions are price spikes at the very start of the production process (the February PPI was shrugged off, but my eyes were fixed on the headline number and the implication for core prices in coming months). The next row to go boom is truckers increasing fuel surcharges, followed by vendors raising prices to customers. (Domino's Pizza (DPZ), for instance, has already had to compensate drivers more for gas expenditures).
I'm not saying anything groundbreaking here, but with the broader market out of the gate vigorously this year, the notion of earnings risk due to energy inflation is underappreciated in stocks. Stocks that have been lifted by a rising macro tide rather than company-specific trends are particularly vulnerable.
There are countless ways to invest amid rising fuel prices. Names like Dollar Tree (DLTR), Exxon Mobil (XOM) and Costco (COST) come to mind on the long side. My preference is to be positioned to benefit from a pullback in stocks of companies fitting all, or most, of the following qualifications:
- Weak industry volumes in the past year.
- Weak appetite for a company's products at higher prices than last year's.
- More being done operationally to drive sales while the earnings result remains subpar.
- The industry is going through fundamental changes that will only worsen as fuel prices rise.
Two prime candidates to bet against on the premise that current earnings expectations will not be met are DineEquity (DIN) and Campbell Soup (CPB). The skinny on DineEquity is that a trip to an IHOP or Applebee's is discretionary and will be curtailed. If the consumer does dine out, it may be at one of Darden's (DRI) restaurants instead because they offer a superior relative guest experience.
Food for thought on DineEquity:
- For hardcore Benjamin Graham disciples, the company's capital structure continues to be horrible, years after its purchase of Applebee's. That leverage is a greater headwind to net earnings as customers retrench on visits and margins compress due to increased fuel and food expenditures.
- Neither chain has served up any confidence regarding pricing power. First, price increases in 2011 were unable to fully offset higher advertising and labor expenses. Second, guest traffic was spotty as the company raised prices, which is an indication that consumers see the dining experience as unworthy of spending a few extra bucks.
- This spring IHOP will transition to a featured-items promotion from a six-week, single-limited-time promotion. In other words, management is attempting to curtail discounting to pad profit margins at precisely the juncture where competitive prices will be needed to drive cost-conscious (fuel and food-cost related) consumers through the doors.
As for Campbell Soup, it joined the list of consumer staples companies that stunk up the joint with earnings reports in February. Although Campbell did not follow General Mills (GIS) and lower its fiscal-year guidance, by putting two and two together it appears that the earnings range reiterated by Campbell will be a stretch to achieve (I also believe forward estimates by the consensus are a reach). My thoughts on Campbell:
- The recent earnings report left me with a single impression: no pricing power.
- The latest turnaround plan is focused on elevating the brand and extending it into new categories. Whenever you hear a company's management refer to "elevating the brand," it's jargon for trying to sell more premium products. The thing with Campbell's new products is that they are not must-haves, are unlikely to hold opening price points, and will enter the market at a time consumers are being forced to make tough decisions on purchases (buy private labels, less of their favorite branded products, switch brand name products if one is on sale).