Wealth Accumulated

By D J Thomas, a large-cap stock market value investor and financial writer

Warren Buffett is holding a boatload of cash

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Warren Buffett

Berkshire Hathaway’s cash increased to $128.65 billion in the fourth quarter of 2022 up from nearly $109 billion in the third quarter according to the latest Berkshire Hathaway annual letter. Even more astonishing is Apple represents nearly 40% of Berkshire’s portfolio, a stock that he purchased more of in Q4. My favourite quote from the annual letter: “When you are told that all (stock) repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive)”. Read the full letter here.

US inflation in January rises higher than expected

The Fed’s preferred measure of inflation – the core personal consumption expenditures price index increased 4.7% from a year ago adding to the expectation that the Fed will have to keep rates higher for longer. Inflation as we all know and love it including food and energy rose 5.4%.

HSBC profits from higher interest rates

Quarterly pretax earnings came in at $5.2 billion versus $2.7b billion for the same period last year. Full-year profits at $17.5 billion were lower than last year’s $18.9 billion due to the costs of selling a French bank. Rising credit losses were blamed on higher inflation.

Walmart and Home Depot: the consumer is under pressure

Walmart CFO John David Rainey: “The consumer is still very pressured… and if you look at economic indicators, balance sheets are running thinner and savings rates are declining relative to previous periods. And so that’s why we take a pretty cautious outlook on the rest of the year.”. Home Depot Chief Financial Officer Richard McPhail: “We’ve seen an increasing degree of price sensitivity as the year’s gone on, which is actually sort of what we predicted in the face of persistent inflation.”

Tesco, ASDA and Morrisons don’t want you to eat real food

The rising costs of production such as energy have curtailed the supply of fresh fruit and vegetables to UK supermarket shelves. As a result, they’ve limited what consumers can purchase. ASDA has introduced ‘MAX3’ – “We have introduced a temporary limit of three of each product on a very small number of fruit and vegetable lines, so customers can pick up the products they are looking for.”

Intel cuts dividend by 65%

There is now open talk of NVIDIA replacing Intel in the DOW after its stock plunged from $68 a share in April 2021 to $25 this week. On top of cost cuts, CEO Pat Gelsinger intends to grow the dividend over time after a drastic cut – “The board and I continue to view the dividend as a critical component to the overall attractiveness of Intel”. A declining PC market and demand for its own products – its customers simply have too many chips and need to work through their own inventories. “While we know this dynamic will reverse, predicting when is difficult”. 

Fed minutes: the inflation fight continues

There are signs that inflation is falling, but labor markets “remained very tight, contributing to continuing upward pressures on wages and prices“. Members believe that ongoing rate hikes will be necessary because more evidence of progress across a broader range of prices would is required. A few members of the FOMC members wanted a half-point or 50 basis-point rather than the recently announced quarter-point rise a few weeks ago.

St. Louis Fed President James Bullard wants rates north of 5%

“We have a good shot at beating inflation in 2023”. Bullard wants rates to go higher now so that in his opinion, the FOMC has a better chance of beating inflation in 2023. “Our risk now is inflation doesn’t come down and reaccelerates, and then what do you do? We are going to have to react, and if inflation doesn’t start to come down, you know, you risk this replay of the 1970s … and you don’t want to get into that. Let’s be sharp now, let’s get inflation under control in 2023.”

The FTSE 100 hits 8000

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City of London

FTSE 8000

The London Stock Exchange has always been a mining/energy-centric exchange which has helped to boost the FTSE 100 over the historic and record-breaking 8000 mark. Putin’s invasion of Ukraine and the fallout from global supply chain issues resulting from the global coronavirus pandemic have helped energy companies listed in London (and around the world) to record profits. The likes of Shell and BP have already seen sharp increases in their share prices as a result. They’re expensive; don’t let their single-digit PE ratios fool you.

UK semiconductors scream for money

And so they should given the massive investment commitments the US government and the EU have made to secure their own supplies of chips. The threat to Taiwan from China has not gone away and they still covet Taiwan’s reunification with the mainland which threatens the global supply chain of chips. iPhones, cars, washing machines – a whole host of everyday electronic items have not been supplied to the market due to the lack of chips and last year’s lockdowns in China. Rishi Sunak needs to announce something soon or risk firms moving operations overseas. The UK’s largest exchange-listed stock, Oxford Instruments, with a high teens ROCE and PER of 26.54 is in growth stock territory. Its half-yearly report showed an almost 18% increase in revenue. Ian Barkshire, Chief Executive said ‘we anticipate higher production in the second half, combined with the positive impact of recent price increases as we convert our record order book. This provides good visibility for an expected improvement in trading in the second half’.

Biden’s bombs

Or tanks. Just keep an eye on Biden’s proposed record defense spending proposals rumoured to eclipse the $858 billion enacted in the 2023 fiscal year. It’s thought that the Pentagon wants to accumulate weapons to refill US stockpiles while continuing to send munitions to Ukraine. I’ll state the obvious: look at stocks in the defense industry that have growth plans beyond the Ukraine conflict and the recent Chinese Balloon shootings. Since a lot of defense relies heavily on tech, defence-orientated tech stocks including cyber security may not go amiss. For example, Lockheed Martin is the US government’s largest defence contractor.

Plus 500 just keeps on making money

The FTSE 250 firm describes itself as a ‘global multi-asset fintech group operating proprietary technology-based trading platforms’. It’s a stockbroker that also allows users to access derivative products such as futures, options, and contracts for difference. Net profit in FY 2022 increased by 19% to $ 370.4 m (FY 2021: $310.6m) and basic earnings per share increased by 25 % to $3.81 (FY 2021: $3.06). Plus 500 has an extremely strong balance sheet. David Zruia, Chief Executive Officer said ‘we are in an extremely exciting strategic and commercial position, with multiple potential growth opportunities available, particularly in the US futures market’.

UK inflation slows in January

10.1% for January versus 10.5% in December the third month in a row of lower CPI according to the Office of National Statistics. Milk and olive oil price increases are making my weekend morning ritual of pancake making even more expensive; as for the eggs required in the recipe, I treat them more like caviar now. Inflation is still at a 40-year high and the Bank of England has already raised interest rates 10 times in a row to 4% with the market expecting rates to rise again when The Bank meets on 23rd March. Remember when inflation was meant to be transitory?

US inflation rises in January

CPI rose 6.4% for the previous 12 months to January 2023 compared with the same period last year. It rose 0.5% for January alone. Shelter, food, natural gas, and filling up your tank were the standout categories influencing the numbers. As inflation stays high, so will interest rates. The market is expecting a 0.25% increase in interest rates at the next Fed meeting scheduled for the third week of March. Dallas Fed President Lorie Logan said ‘we must remain prepared to continue rate increases for a longer period than previously anticipated, if such a path is necessary to respond to changes in the economic outlook or to offset any undesired easing in conditions’.

Why Adidas is a relatively unpopular large company

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An adidas trainer, black and white

Adidas reeling from Kanye colab

“The numbers speak for themselves. We are currently not performing the way we should,” CEO Bjørn Gulden said in a press release this week that also alluded to its inability to sell its Yeezy inventory with a potential impact of $1.3 billion. Last October the firm severed ties with Yeezy’s founder Kanye West after his well-publicised antisemitic tirades. In July 2021, shares traded at EUR319, today they’re at EUR139, with a dividend yield of 2.37%, and a PE ratio of 19. Adidas has all the hallmarks of a relatively unpopular large company.

Rinse and repeat

As if we didn’t get it first time around last week when the fed increased interest rates by 25 basis points, Fed chair Jerome Powell at the Economic Club of Washington said “the disinflationary process, the process of getting inflation down, has begun and it’s begun in the goods sector, which is about a quarter of our economy,”. Of the labor market, Powell ‘didn’t expect it to be this strong’ after a 517,000 print for jobs added in January. Those damned workers are just fouling the recovery. “My guess is it will take certainly into not just this year, but next year to get down close to 2%.” That’s a bet I’m willing to take.

Record profits at BP

Like ExxonMobil and Shell last week, the energy sector continues to reap the benefits of lockdowns and Putin’s invasion of Ukraine creating massive demand for oil with BP announcing record profits that more than doubled to $27.7bn (£23bn) in 2022. In the fourth quarter of 2021, Chief executive Bernard Looney said: ‘When the market is strong, when oil prices are strong and when gas prices are strong, this is literally a cash machine.’

A high dividend yield at Barrett Developments

With a dividend yield of nearly 8%, property developer Barratt Developments released its half-year results this week and decided to cut its dividend. David Thomas, Chief Executive said ‘Whilst we have seen some early signs of improvement in current trading during January, we will need to see continued momentum over the coming months before we can be confident that these challenging trading conditions are easing’. Pre-tax profits, earnings, and revenue all increased versus the same period last year. Forward sales were reported as 10,854 homes v 15,736 last year and the firm pointed to the pressure first-time buyers are under, roadblocking a clear pathway to recovery in 2023. Barratt has a PER of 5.78 and a price to tangible book of 1.03.

Disney cuts 7000 from workforce, proxy fight is over

Activist investor Nelson Pelz bought Disney stock at $92 a share in November 2022 for $865 million, launched a proxy fight and now the stock is worth $118 a share – a paper profit of $154 million after his stake increased in value to $1.1 billion. Peltz called off the fight this week after the announcement of a cost-cutting plan to the tune of $5.5 billion and a headcount cull of 7000 employees. Disney announced quarterly earnings per share of 99 cents, beating expectations, and revenue and subscriber numbers that came in as expected. Bob Iger said that “We believe the work we are doing to reshape our company around creativity, while reducing expenses, will lead to sustained growth and profitability for our streaming business, better position us to weather future disruption and global economic challenges, and deliver value for our shareholders”.

Bellway’s strengthening balance sheet

Like Barratt Developments, Bellway’s forward sales have declined and its customers are struggling with increased pressure from higher mortgage rates. Like all good housebuilders, it has large cash reserves and expects revenue to increase throughout 2023 despite the economic backdrop. ‘As the near-term economic outlook remains uncertain, we continue to take actions to maintain the Group’s balance sheet resilience. The measures include a freeze on new recruitment, limiting land approvals and a highly disciplined approach to production expenditure, as we align investment in work-in-progress to sales demand.’ When interest rates decline, you’ll find that demand for their homes will start to increase. In this climate, its easier for housebuilders to build their balance sheets rather than homes.

UK avoids recession

GDP fell 0.5% in December but that was not enough to impact growth for the final three months of 2022, coming in at 0% growth for the quarter. Last week The Bank of England said that it still expects a recession for the UK in 2023, but at a reduced severity than their previous forecast. The Office for National Statistics said that there were falls in services, education, and transport. Britain is scraping along the bottom quite nicely thank you.

How earnings from oil smash records whilst tech disappoints

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ExxonMobil gushes $56 billion in profits

It’s a record yearly profit for the company which previously stood at $45.2 billion in 2008. That was when oil hit $142 a barrel. The EU pre-empted Exxon’s swag with a $1.3 billion windfall tax in the fourth quarter. Shares finished the week at £112 also an all-time high for the firm. As noted two weeks ago, Putin’s invasion of Ukraine will prompt eye-watering earnings from the energy sector. Exxon’s Chief Financial Officer Kathryn Mikells said ‘strong markets, strong throughput, strong production, and really good cost control’ helped the firm to its record earnings.

Google earnings drop in Q4

Alphabet’s earnings came in at $1.05 per share, revenue came in at $76.05 billion continuing a downtrend trend in quarterly revenue growth since Q2 of 2021. In November 2021, shares reached an all-time high of $148 and have since fallen 29% to $105. The company also warned of a $2.3 billion charge it will sustain in Q1 of 2023 related to the 12,000 employees it fired in January. Further charges related to real estate – specifically its reduced office space, will start at $500 million in Q1 and further real-state charges are likely moving forward. Headcount growth cost it an extra 10% in operating expenses but CEO Sundar Pichai reiterated its focus on AI. With Google’s current legal proceedings in the US, there’s a lot for the executive team to be working on and shareholders to be mindful of.

Apple earnings growth slides

CEO Tim Cook blamed the macroeconomic environment and the lockdowns in China for not producing enough iPhones and iPads to sell for the latest quarterly earnings decline. Apple posted EPS of $1.88, down 10.9% YOY, revenue was down 5.49% YOY. Apple’s quarterly earnings have been declining in growth since the beginning of 2021, albeit from lofty heights (54.1% in Q1). The firm said that production levels of the iPad and iPhone are back to ‘acceptable levels’. The number of Apple active devices increased from 1.8 billion to 2 billion, including first-time buyers of the Apple Watch. Cook mentioned costs are being cut and hiring has slowed but did not see a need to slash headcount like others in the tech space. Despite the negative decline in earnings growth, Apple has faired much better than its tech peers due to prudent management of its hiring process, innovative product expansion (Apple Pay, Card, Music), and bringing new customers on board its product range despite the macro headwinds of the last few years: resilience.

Amazon issues guidance for Q1

Amazon expects YOY growth of revenue of between 4% – 8%, and online store sales declined 2% YOY. Consumers are slowly switching from e-commerce to high-street shopping since the end of the pandemic. CEO Andy Jassy, on top of announcing an 18,000 headcount cull last month, has frozen hiring, halted warehouse build, and is ‘… working really hard to streamline our costs and trying to do so at the same time that we don’t give up on the long-term strategic investments that we believe can meaningfully change broad customer experiences and change Amazon over the long term’. Amazon Web Services – its cloud business – declined in growth for the fourth quarter from 27.5% in the third, to 20%. Amazon earned 3 cents per share and operating income declined YOY due to $2.7 billion of charges, some of which related to severance payments. Shares are trading at $103, down from $183 in November 2021.

Meta shares explode 23% after results

Meta shares rocketed 23% in after-hours trading when the firm announced a $40 billion stock buyback, and beating revenue expectations for the fourth quarter. CEO Mark Zuckerberg said Meta’s “management theme for 2023 is the year of efficiency and we’re focused on becoming a stronger and more nimble organization.” Meta announced 11,000 layoffs last November. There’s also less expenditure expected in the future due to a switch to more cost-effective data centres. The Reality Labs unit responsible for the development of the Metaverse is expected to increase operating losses in 2023 ‘significantly’. Shares are currently trading at $186, down from $378 in September 2021. Without the share buyback, the value of Meta is in decline due to weak advertising demand and Tik Tok dominating ad revenue growth. Meta’s ad revenue declined 4% in the quarter and continues to be ‘impacted by the uncertain and volatile macroeconomic landscape’ according to Meta CFO Susan Li. Ad revenue represented 97% of Meta’s total revenue in the quarter.

Shell’s 115-year profit record

$39.9bn (£32.2bn) in 2022, the highest in its 115-year history. The price of Brent crude oil went to almost $128 a barrel after Putin’s invasion of Ukraine last year. It’s currently trading at $83. Shell said was due to pay $134m in a UK windfall tax for 2022 and more than $500m in 2023. Shell had paid $13bn in taxes globally in 2022 and only derives around 5% of its revenue from the UK.

US raises interest rates by 0.25%

The market expected it and The Fed delivered. A rise of 25 basis points from Jerome Powell and his team this week, the highest since October 2007. Inflation is still at its highest levels since the 1980s. Powell noted that inflation “has eased somewhat but remains elevated… inflation data received over the past three months show a welcome reduction in the monthly pace of increases… while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path.”

UK interest rates highest for 14 years

The Bank of England raised interest rates by 0.5% to 4%. The market is expecting rates to peak at 4.5% in the summer before heading back down. The Bank has a 2% inflation target but prices are rising at 10.5%, a 40-year high. The market believes inflation reached its peak in the UK last October at 11.1%. Both the Bank of England and The Fed are in lockstep both with inflation and rate rises, but not on the upcoming recession – the IMF stated this week that the UK will be the only major economy to shrink in 2023, forecasted to be -0.6%.

Diageo: the world’s greatest boozer

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Diageo and it's suite of branded premium drinks
If you like boozing premium brands, Diageo’s your best friend

Wealth Accumulated is long Diageo (LSE: DGE) after an extremely positive half-year report from the firm.

Diageo is a London-listed owner of over 200 premium drinks brands that sell to over 180 countries.

Jonnie Walker, Guinness, Baileys, Smirnoff, Captain Morgan, and a suite of Scotch Whiskey Diageo brands itself as the world’s foremost premium drinks brand builder.

Let’s take a look at the latest numbers:

  • net sales of £9.4 billion, up 18.4%
  • organic net sales grew 9.4%, with growth in all regions
  • operating profit of £3.2 billion, up by 15.2%
  • basic earnings per share of 100.9 pence, up by 19.7%
  • Free cash flow of £817 million, down by 48%

Free cash flow tanked, here’s what the firm offered as a reason for the fall in FCF (emphasis mine):

… a higher year-on-year working capital outflow, higher cash tax and interest paid, and increased capital investment. The higher year-on-year working capital outflow was due to the normalisation of creditors relative to the first half of fiscal 22, as our growth rate began to moderate in the first half of fiscal 23…

Diageo half-year report, 26th January 2023

In other words, as sales began to slow interest payments became more expensive.

More cheerfully, growth in revenues and operating profits were attributed to ‘premiumisation’ – consumers turned to premium drinks brands despite the high cost of living to treat themselves, even though they cut spending in other areas of their lives.

Diageo also noted that ‘price increases and supply productivity savings more than offset the impact of absolute cost inflation on gross margin.’

Scotch, tequila, and beer accounted for the most favoured drinks from consumers and the most growth in sales.

All-in, a good set of numbers for a global brand navigating the fall-out of covid.

The Diageo balance sheet

Specifically the debt.

In the highly upbeat report, there was little mention of the debt by management so it pays to dig a little deeper into how strong the balance sheet actually is.

Diageo has always carried a lot of debt relative to its equity but the firm touted a ‘strong balance sheet’ on the basis that its leverage ratio (adjusted net borrowing to adjusted EBITDA) is 2.5x as of 31 December 2022, the lower end of its target range.

It was able to remain within the lower end of its target range by adding back increased finance charges, an exceptional intangible impairment, and an exceptional operating item to the calculation of EBITDA.

This had the effect of masking the increased indebtedness Diageo had undertaken in the period.

This financial manipulation is not new and attempts to curve fit a firm’s financial strength into the false safety of a ratio that does little except to hoodwink investors.

A much better look at Diageo’s financial strength is as follows for the six months to 31st December 2022:

  • Market cap: £76.88 billion
  • Net debt: £15.16 billion
  • Revenue: £9.4 billion
  • Pre-tax profit: £3 billion

No doubt there are disposals in the pipeline for Diageo as it seeks to strengthen it’s brand offering by acquiring premium brands around the world which could be used to pay down debt.

But from a cash flow and financial strength perspective, I wouldn’t like to see net debt go much higher than it is already since its assets (and liabilities) held for sale, including Guinness Cameroon S.A., amount to only £106 million.

Can Diageo handle the debt?

CEO Ivan Menezes was confident about Diageo’s future prospects:

As we look to the second half of fiscal 23, whilst the operating environment remains challenging, I remain confident in the resilience of our business and our ability to navigate volatility. We believe we are well-positioned to deliver our medium-term guidance of consistent organic net sales growth in the range of 5% to 7% and sustainable organic operating profit growth in the range of 6% to 9% for fiscal 23 to fiscal 25.

Ivan Menezes, CEO, Diageo

These growth targets are already being met and the challenge for Diageo is to continue to meet them for the rest of 2023 and beyond. A target they have set themselves.

From a section entitled ‘fiscal 2023 outlook’:

In North America, organic net sales grew 3% in the first half of fiscal 23. We expect organic net sales growth to continue to normalise through the second half of fiscal 23, compared to the double-digit growth in the prior period. In Europe, we expect organic net sales growth to moderate in the second half of fiscal 23 as we lap on-trade re-opening recovery. In Asia Pacific, Latin America and Caribbean and Africa, we expect continued growth through the second half of fiscal 23, albeit at a moderated pace relative to the strong growth in fiscal 22.

So slower growth, but growth is forecast nonetheless and it’s fair to say that the strength of their brands and the continued investments in ad spend and premium brand acquisitions should help them achieve their targets.

Why I didn’t buy this stock when it was £25 – £30 a share is beyond me, but I’m in at an elevated price so Diageo represents a smaller percentage of the overall portfolio for now.