April 29, 2020
Drinking from a Firehose - Q1 2020 Earnings continued
Earnings: The flow of earnings and market-impacting economic news this week is like a drink from a firehose. Approximately one-third of all public companies have reported Q1 2020 earnings. By the end of this week, approximately half of the public companies will have released earnings. While many public companies have ceased providing forward guidance, there is quite meaningful forward-looking information in these earnings. What companies are doing in their behavior is much more revealing than what they say - or could offer - in projecting forward financial ratios and metrics. For example, going beyond deferring future CapEx projects to suspending dividends and workforce cuts is a meaningful form of forward guidance. And these earnings are quite pertinent to our real estate community. Many company earnings can be a proxy for what is likely to play out in the Alabama economy. For example, Boeing’s earnings and their response to travel dislocation should encourage “what-if” thinking concerning Mobile, Alabama’s Airbus manufacturing plant. Both Boeing and Airbus will be adversely impacted by the 95% contraction in airline travel and the demand destruction for new airplanes that results. And, public home building companies, such as a Pulte and DR Horton, foretell what is already occurring in housing that we will not see for months from housing sales data. What these builders are telling us now will likely play out in Alabama housing markets too. As goes large public builders with regard to land acquisition, lot purchases, and lot takedowns under option contracts, spec home inventory, and pricing flows downstream to regional and local homebuilders. More on the earnings to follow.
Economic Data: The flow of economic data this week also feels similar to a drink from a firehose. The first quarter of COVID-19 impacted GDP revealed the longest recovery on record ended with a contraction of -4.8% for Q1 2020. This April 29, 2020, BEA released figure is the “Advance Estimate” with revisions to follow in May and June. The revisions will most likely portray a worse decline. This is what that decline looks like now:
Despite the near -5% GDP contraction, it was not as bad as anticipated. Keep in mind, though, that part of the reason was attributed to an unprecedented decline in imports not rivaled since the 1970s. Imports subtract from GDP. When they decline, it mitigates/masks the full impact of slowing organically produced, domestic GDP and exports. That behavior is at play here in Q1 – and it will likely reverse in Q2 as Asian imports flow back into the West Coast ports. The full impact of 25 million unemployed is also not fully cooked into these GDP figures. The forward view that GDP will contract further is valid, but I am not in the camp that Q2 or Q3 GDP will contract as much as the 20% figures being bantered around. Why? First, the trillions injected into the economy by both Congress and the Federal Reserve is not being factored into the GDP outlook. Fed Chair Powell reinforced this on April 29, 2020, in his post-FOMC briefing by noting how many of the announced asset purchases, Corporate Conditions Facilities, and soon to be implemented Main Street facility are yet fully deployed. That liquidity infusion has spiked the Federal Reserve balance sheet from less than $4 trillion at the end of 2019, to over $6.0 trillion in the past 8 weeks. Consensus forecast is the Federal Reserve’s balance sheet could balloon to $12 trillion by Q1 2021. For some perspective, the markets were anxious during the 2009-2010 Financial Crisis when the Fed’s balance sheet surpassed $4.0 trillion. This COVID-19 recession will see the Fed triple that figure. All that liquidity will likely keep GDP contraction to a -10% range and is intended to prevent greater than 10% unemployment and more than 10% GDP contraction.
FED Balance Sheet Expansion 2009 Fin Crisis $4.3Tr Vs Phase 1 of COVID 19 Intervention April 2020 (6.62 trillion)
Housing: There was more major economic news as well. The National Association of Realtors April Pending Home Sales experienced their largest single-period decline in 12 years of -20.8% with the South region only marginally better with a decline of -19.5%. For comparison, the median forecast in a Bloomberg survey of economists called for a decrease of 13.6% - and compared with a year earlier, contract signings dropped 14.5% on an unadjusted basis. The mitigating news, though, is that the U.S. now has more new homes for sale than existing homes (the inventory shortage challenge is getting some relief). Existing-home sales for April will be reported May 21, 2020. The next Pending Home Sales Index will be May 28, 2020. Stay tuned and monitor listings activity and new home purchase indicators such as mortgage applications.
Mortgage Applications: Also related to the housing industry sector was updated mortgage applications data from the MBA (Mortgage Bankers Assoc.) According to the MBA, the noteworthy items for April were:
- i. purchase applications, recovering from a five-year low, increased 12% last week to the strongest level in almost a month;
- the 10 largest states hit hardest by COVID-19 had increases in purchase activity - potentially a sign of the start of an upturn in the pandemic-delayed spring homebuying season; and,
- ii. the most adversely hit purchase activity states – California, Washington and New York - are beginning to show some significant gain after declines in five of the last six weeks. And this news can potentially get even better with the low interest rates. Mortgage rates fell to another record low in MBA's survey, with the 30-year fixed rate decreasing to 3.43%. The refinance share of mortgage activity decreased to 71.6% of total applications from 75.4% the previous week. The decline in refinance activity (down 7%) is due primarily to lenders working through pipelines which are at maximum capacity. Finally, the MBA is paying attention to public builder earnings and noted in their press release that new buyer traffic is more urban apartment dwellers looking at available and vacant new home inventory in the suburbs. Could we be seeing a reversal of the urban dwelling trend back to the suburbs for density and affordability reasons as a result of this crisis?
Federal Reserve’s April FOMC Meeting: Finally, regarding the economic news front was the Federal Reserve’s April FOMC meeting on April 29, 2020. Chairman Powell was candid and gave the market straight forward answers and guidance. He reaffirmed the Fed intervention is not short term and should be viewed over a horizon of one to two years. Many of the facilities being implemented now, like the Corporate Credit Facility or broader Main Street Facility, are just commencing in May. They will take an extended period of time to run their course. If more intervention is needed, the Fed will use “all its legal authority from Congress to act.” Nobody should consider rate hikes in 2020. The chairman voiced a few new thoughts that are motivating his thinking:
- First, the restarting of the economy is going to be slow. Chairman Powell most fears a second outbreak without a vaccine or more testing.
- Second, there could likely be systemic structural damage to the economy the longer workers are unemployed (their skill sets require updating like an airline pilot or highly skilled manufacturer at, say, Boeing) and businesses remain closed.
- And third, the loss of small business impacts communities and has interconnected consequences to related industries, such as restaurants and hotels in tourist destinations.
Referencing the ACRE “Who’s Still Working” COVID-19 feature from April 27, 2020, the Federal Reserve is definitely working!
A few key dates to note regarding future Federal Reserve events or releases are:
- May 20, 2020 – Release of the FOMC minutes from this April meeting.
- May 27, 2020 – Beige Book update. Alabama is in the Atlanta Fed District Bank. Comments relating to business conditions relative to the southeast states of Alabama, Georgia, Florida, part of Tennessee, and Mississippi are in the Atlanta Fed District. Outside the Atlanta Fed District, note the St. Louis, Kansas City and Dallas Federal Reserve Banks’ comments in the May 2020 Beige Book as there are many synergies. Like earnings, great “Look Up & Forward” insights are contained in the Beige Book as all comments are derived from businesses and industries in the respective districts.
- June 9-10, 2020 – Next FOMC meeting. This will be an important one to attain a report card on how the intervention facilities are working and the FOMC Committee’s view on progress from states reopening economies.
- Finally, note there are no FOMC meeting in 2020 for the months of August or October.
Earnings Lightning Roundup Half-Way thru Q1 2020:
We started Q1 earnings with the banks. We learned three key items:
- i. large banks like JPM are beating revenue expectations on all the bond, securities and related trading activity from COVID19 disruption;
- ii. banks are not losing money as suggested by the much contracted earnings or EPS; rather, they are just moving the pot of money from earnings to loan loss reserves in case the Fed intervention does not work and loan losses rise, and,
- iii. the banks were ill prepared to handle a Paycheck Protection Plan (PPP) and that leads to some anxiety about how effective the Fed will be with future facilities like the Main Street Lending Facility if the banks are to be the conduit for delivery.
Then last week we progressed to some early non-bank entities, such as ProLogis. They revealed some most forward-looking insights for those connected to logistics, ports and rail, or industrial CRE:
- E-commerce is driving increased demand - and it’s broader than mall and department store type merchandise and includes more perishables and need for refrigerated warehouse space. Demand for e-commerce type space has doubled.
- March and April Rent collection was 85% and within 1% of a normal/pre-COVID month.
- Forward-looking data continues to be encouraging. During the last 30 days, ProLogis signed 198 leases amounting to 17.5 million square feet. That's up 21% year-over-year and roughly flat adjusted for portfolio size. Even “lease proposal generations” are up 21% year-over-year. And retention was just over 80%, a couple of hundred basis points higher than comparable historical periods.
- Rent relief is targeted at our smaller customers with legitimate need stemming from coronavirus and not for opportunistic requests.
- Finally, they are seeing the early signs of a shift from just-in-time inventory supply-chain management to the growing importance of safety stock. That shift will lead to more warehouse demand than even pre-COVID-19. The value in these earnings releases can not be under-estimated. The aforementioned guidance is found gold if you are an appraiser, broker, banker or property manager with industrial real estate assets. I would encourage supplementing the likes of a ProLogis with the rail and transport companies – like KSU, CSX and Old Dominion. Before, during and after COVID-19, earnings are your best source for forward-looking intelligence!
And then this week the earnings flood gates opened with approximately one-third of public companies reporting. Below is a lightning round of some key companies and insights germane to commercial real estate and the economy:
- D.R. Horton: They are the nation’s largest home builder active in Alabama, especially in the Gulf Coast region. They turned in a stellar 40% increase in earnings with revenue up 9%. They had no challenges closing homes. Approximately 14,500 home were closed – up 8% YOY. The key takeaways were that vacant new homes in affordable price points are selling and the largest segment of traffic is urban millennials looking to leave the dense urban areas in favor of the suburbs for both density and cost reasons.
- Weight Watchers (WW): Some of what was noted in the conference call by their CEO Mindy Grossman holds insights for gyms in retail centers. WW was ready for a pandemic from being engaged in “Retail e-Volution.” They easily pivoted from in-person meetings to virtual and experienced an all-time high in subscribers in Q1 (5.0 million). In other words, physical to virtual did not hurt revenues or subscribers. They also revealed that the quick pivot to virtual using Zoom has enabled WW to attain more detailed data about their subscribers and their needs and interests in WW products, food and services. WW is now 25% face-to-face subscribers and 75% digital. The customer satisfaction results for March were 97%. Digital can work. And the numbers backed it up for WW. There are lessons to be learned from WW on how to pivot to digital and not lose subscribers or customer satisfaction. Gym chains in your retail might want to study the WW model.
- Akami: This may seem like an odd one to cover but they are the company that builds the networks to boost the speed and bandwidth of commercial users like cities, governments, Zoom, Verizon, etc. They are that turbocharger under the hood of your car that gives your Internet activity speed. Their global traffic and commercial users are up 3% globally and their CapEx spend is not going to slow. It is buzzing ahead in the high teens of gross revenues. This is a most profitable tech growth company essential to more e-commerce and digital everything from Netflix viewing and downloads to remote learning and Zoom everything at work.
- Hasbro: This toymaker demonstrated the importance of connecting the dots regarding supply-chain risk management. They had begun to pull back on manufacturing expansion to Asia during tariffs and were able to pivot manufacturing back to Massachusetts and Rhode Island as the pandemic began as early as last holiday season. They also noted that COVID-19 is accelerating more of their business online and it will accelerate store closings. Finally, their strategy to develop more digital toys and embrace online community gaming (not the kind you think but the kind we have discovered at home during coronavirus with our legacy board games) with concepts like Magic Arena. Another is called House Party. The lesson here is twofold: i) supply-chain matters; and ii) you can make something old (board games) new via digital technology and Zoom.
- Boeing: The numbers were worse than expected. Its earnings highlight that there is no way out for Boeing, commercial airlines or airline manufacturing from others like Airbus when 95% of travel is idled. The sobering comment in Boeing’s CEO conference call was that demand for new aircraft has been damaged for at least 3-5 years. More orders will be cancelled. Airlines may opt for bankruptcy over the government bailout offer not just to avoid giving up partial ownership and control of their airline, but to be able to renegotiate or cancel aircraft orders, airport gate contracts and more. Finally, a revelation regarding aircraft orders was that after a 12-month period of delay in delivering an airplane, the order is cancellable. Boeing now faces that with all its 737 MAX orders. The commercial airline industry is facing its darkest days and the industry is now admitting that the carnage will impact for years. All related to it need to “fasten their seatbelts.” By the way, the CNBC trivia question for April 29, 2020, related to Boeing. The question and answer were:
Q: Who owns the world’s largest building/enclosed structure?
A: Boeing – Their Everett, Washington, manufacturing facility spans 99 acres of enclosed space.
- GE: Let us just say it was ugly and further amplifies the interconnectivity of Boeing to so much in our economy. When the largest manufacturer and exporter in the U.S. goes down, it ripples through a lot of supporting companies across a large geography.
There were many more earnings releases, but these highlight some relevant takeaways for our CRE industry and Alabama economy. Get ready for energy on Friday (it may be worse than the airline industry); however, Clorox closes out Friday with an earnings results that may disinfect any losses for the week and leave the market sanitized and ready for May retailers.
Conclusion: ACRE is made up of relationships and a real estate community that extends well beyond Alabama. Last Friday, one of our National Network sponsors lost a key family member. The matriarch of Monmouth MREIC – where I also serve as an independent director on their board of directors - Gloria Landy, lost her battle with illness. Her life of service to others and support for her husband and children in building one of the most successful and valued industrial and affordable housing REITs in existence (MREIC and UMH – both on the NYSE) is worth remembering. Like so many of the founders of great Alabama and CRE companies, the matriarchs and patriarchs are the Greatest Generation of our industry that laid the foundation for commercial real estate to grow to the institutionally accepted asset class it is today. ACRE extends its sympathy and prayers to the Monmouth family and wishes to share part of Gloria Landy’s obituary to appreciate the significance of her life. I hope you agree after reading the following.
“Gloria Sadoff Landy, age 86, of Rumson, New Jersey passed away Thursday, April 23, 2020 at her home. She was born in New York City on August 12, 1933, the oldest of two children to Samuel and Eva Sadoff. While most of her family members in Europe died during the Holocaust, Gloria’s parents worked hard to help survivors build new lives here in America. Gloria and her brother Leon grew up as active members of the Old Broadway Synagogue in Harlem, New York. She married Eugene Landy in 1957 and worked as a paralegal supporting him while he attended Yale Law School in New Haven, Connecticut. Eugene and Gloria raised three sons, Samuel, Michael, and Richard Landy. Gloria devoted her life to Jewish causes and the State of Israel and worked tirelessly in these efforts. Gloria was the first woman President of Congregation B’nai Israel in Rumson, New Jersey, and remained very involved in all aspects of the synagogue, most particularly youth education, throughout her life. She worked for many years at the United Nation’s headquarters in New York City as a leader in the Jewish NGO Caucus. In 2014, she was elected Secretary of the World Jewish Congress where she served with great pride and distinction. Her strong voice of solidarity with the Jewish community and the Jewish State was always loud and clear in the public square and in the diplomatic arena. Gloria was also a gifted poet and served as the President of the New Jersey Poetry Society for several years. She was a voracious reader and writer and had great admiration for the works of William Shakespeare, Fyodor Dostoevsky, and Elie Wiesel who she was proud to call her friend. Gloria was a beloved wife, mother, grandmother, and great grandmother.”
One of her lasting legacies will be her poetry. She was an accomplished and published poet in New York. Monmouth CEO and devoted son Michael Landy shared one of her most recognized poems that was published in 1977. Thank you Gloria Landy for a life well lived and devoted to serving others. ACRE extends its heartfelt sympathy and prayers to the Monmouth family. Whether you knew Gloria Landy or not, we are richer for her life, devotion to service, and poetry.
Until next week -KC
ACRE remains committed in its COVID-19 coverage at exploreACRE.com to bringing you the insights needed to “Look Up & Forward,” and do the necessary “what if” thinking.
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