March 2016 – AZ to NY Investing

I want to express my condolences to all of the families currently affected by the terrorist attacks in Belgium. Ok, now I want to point out that I’m an arrogant college student whose condolences mean shit. People offer their grievances in catastrophes such as this, thinking that it shows an awareness or an emotional attachment that transcends self-interest. In reality we just perpetuate that ignorance and selfishness we were trying to avoid in the first place. These petty attempts of compassion, whether changing your profile picture to a French flag or updating a status to “stand in solidarity” with the victims, only continue to belittle the actual tragedy. We internally find some satisfaction in these tragedies as we convince ourselves that we are patriots of freedom fighting to defend the all that is ‘good’ in this world. The media makes it even worse as they find ways to turn the attacks into a political landscape on what presidential candidate would handle these types of situations more effectively. So how do we avoid this paradox of altruism versus egocentricity? We can be more constructive by attempting to engage people directly who have been personally affected by these events, we can continue to promote intellectual discourse to try and better understand the conflict between fundamentalism and capitalism, and finally we can look for ways to support the community around us fighting hate with actions of kindness and compassion.

Well that’s not what I originally planned to write about. I just became more side-tracked then “Squirrel!” that talking dog in the Disney movie UP. Anyway let’s look at some economic data. I’ve been slacking in my analysis of the US economy as my recovery from Spring Break in Cancun took longer than I anticipated.

GDP and Corporate Earnings– March 25^th 2016

The third revision for the GDP in Q4 increased to 1.4 up from the advanced estimate of 1.0. The overall state of the economy performed better than anticipated which the Fed might use to as reinforcement for raising interest rates.

Corporate profits had a dismal Q4. The profits from current production decreased $159.6 billion, up from $33.0 billion in Q3. Profits of domestic financial corporations decreased $24.0 billion in Q4 which is much lower than the increase of $1.8 billion in Q3.

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

Durable Goods Report – March 24^th 2016

New Orders for manufactured durable goods decreased $6.6 billion by 2.8% in February following a 4.2% increase in January.

Shipments decreased $2.1 billion in in February down .9%.

Inventories of manufactured durable goods in February, down seven of the past eight months decrease $1.1 billion, down .3%.

There continues to be this weakness in durable good, especially in transportation. However, after reading the WSJ people l could barely find an article where any investors show concern.

http://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf

Markit Flash Services PMI – March 24^th2016

US Services indicated a rebound in March after “A decline driven partly by east coast snow disruptions in February”. The consensus called this rebound “marginal” suggesting a slowdown in growth momentum. The index was 51.0 in March up from 49.7 in February. This average reading for the first 3 months of 2016 (51.3) was the lowest quarterly expansion pace since Q3 2012. This is also the softest expansion of growth since the survey began in October 2009, the beginning of the Recession! The reports detailed uncertainty in the future business environment with subdued business optimism.

One positive was that the rate of hiring stayed around 200,000 growth in March. According to Chief Markit Economist Chris Williamson “Such strong hiring at a time of weak output growth suggests productivity is trending down at the fastest rate seen over the past six years.

https://www.markiteconomics.com/Survey//PressRelease.mvc/673fe609a2ec4e6d8835ef927a94a1bf

Kansas City Fed Manufacturing Survey – March 24^th 2016

Factories reported another decline in March although the drop was smaller than in the previous three months. The index was -6 in March up from -12 in February and -9 in January. Manufacturing is still struggling to rebound. The capital expenditure index declined from -10 to -19, declining to its lowest level since December 2009 with a lot of this decline coming from the energy sector.
While capital spending is still constrained some believe that there are new potential business opportunities in the manufacturing industry.

https://www.kansascityfed.org/~/media/files/publicat/research/indicatorsdata/mfg/2016/2016mar24mfg.pdf?la=en

Existing Home Sales in February 2016 – March 24^th 2016

Existing Home Sales were down 7.1% in February to 5.08 million. Despite the continued improvement in the labor statistics the sales are meaningfully lower now than one year ago. There was a decline in inventory from last year by 1.1% but was up for the year in 3.3% for the month. The unsold inventory was up 4.0%.

Home prices were up despite the weakness sales activity and have been rising faster than wages. The decreasing affordability and the increased economic uncertainty have been headwinds to consumer spending on houses.

http://www.realtor.org/news-releases/2016/03/existing-home-sales-fizzle-in-february

Like Smalls in the movie Sandlot I’m new to the game. I haven’t been around long enough
to understand the implications of terrible economic data such as the numbers that we have been recently receiving. I’m still figuring out the weight of importance that corporations, the Fed, and the US government put on reports such as the ones above. Maybe these numbers don’t mean that much. Maybe they aren’t nearly as important as the unemployment rate or the number of people entering the workforce. But as a rational investor I would have to consider these numbers to be significant indicators of the poor state of the US economy. I just wonder if the Fed feels the same… and if this will change their minds on raising rates in April.

This article is the first of five where I create a portfolio of companies who make billions of dollars promoting the hedonistic tendencies that humans are prone to. Call it a portfolio of perversion, an index of immorality, a database of debauchery, a group of gluttony, a… a… call it a Sindex! (Cue the fireworks) My sindex will include companies from all different industries including alcohol, tobacco, gambling, cruise ships, and military. And who knows I might even throw in one of those damn big banks (Don’t let my employer read that). So let’s get right to it and start with the alcohol industry.

Diageo PLC (NYSE: DEO) is a premium drinks business with a collection of spirits, wine, and beer. These brands include Johnnie Walker, Crown Royal, J&B, Windsor and Buchanan’s whiskies, Smirnoff, Ciroc and Ketel One vodkas, Baileys, Captain Morgan, Tanqueray and Guinness. In 1997 Diageo was created through the merger of Grand Metropolitan Public Limited Company and Guinness PLC, creating a diverse food and drinks conglomerate. Between 2000 and 2002 they exited the food industry divesting Burger King and Pillsbury. That is when Diageo began to focus specifically on premium beverage alcohol. After this decision Diageo began to acquire additional spirits and wine brands from Seagram, and through other long-term acquisitions. They operate as 21 geographically based markets around the world and have a presence in over 180 countries.

Brown-Forman (NYSE: BF.B) founded in 1970 has accumulated a portfolio of more than 30 spirits, wines and cocktails. Their most famous brand, Jack Daniel’s Tennessee Whisky, is complemented by other brands such as Southern Comfort, Pepe Lopez Tequila, and Finlandia Vodkas. With their headquarters in Kentucky Brown-Forman is largest American-owned spirits and wine company with a global reach. Brown-Forman’s first priority is to develop organic growth of their current portfolio while encouraging innovation and considering acquisitions.

Diageo has been considered to be toward the end of its growth stage with revenue growth having slowed 2.03% in the last 5 years and 4.87% in the last 10 years. However, Diageo in 2015 had $10.8 billion in revenue and adjusting for currencies they are on track. Reported net sales were up 5%, largely driven by the full consolidation of United Spirits, which contributed £921 million of net sales. Currency weakness, other than the US dollar, had an adverse impact on net sales.

Organic volume decline was largely driven by lower shipments in the United States, reduction in inventory levels in South East Asia and West LAC, and the impact of pricing in Venezuela and Brazil. While these price increases contributed to positive price, the main driver of organic price/mix was led by growth of reserve and Crown Royal. In the second half of 2015 Diageo displayed positive results in emerging markets. In Africa, one of Diageo’s greatest growth prospects, volume was up 7% for the second half of 2015 driven by growth in beer such as Guiness. Beer volume grew 23% as Senator more than doubled in size following the duty roll back earlier in the year. In Latin America volume was up 4% with all markets delivering volume growth. Mexico was the biggest contributor.

The volume and revenue decline in North America is less worrisome when you take into account the replenishment (mega-shipments creating more efficient inventory management) of new Ciroc brands. This was mainly driven by the reduction in the volume of Cîroc against the prior period when 750k cases were shipped for the launch of Cîroc Pineapple. In comparison, in this half for the launch of the new Cîroc flavour, Cîroc Apple, which occurred later in the half, 250k cases were shipped.

Average net debt decreased by about £1 billion largely as the result of proceeds from disposals. Diageo significantly reduced net debt and modestly lower rates. Through increased payments of principle Diageo saved $30 million on interest expenses.

In the second half of 2015 Free cash flow improved by £140 million reflecting Diageo’s focus on cash conversion. The Cash Return on Invested Capital (CROIC) tells us how much FCF the company produces for every dollar of capital invested in the business. Diageo’s fairly dramatic restructuring of its business in recent years is helping to improve CROIC against peers and has the potential for a great 2016.

Diageo has continuously emphasized innovation of their brands for every spectrum of value (Higher quality versus lower cost). Diageo continues to roll out successful new products such as Crown Royal Apple. They have focused on ramping up powerful marketing campaigns for brands such as Captain Morgan, Smirnoff and Crown Royal. They are continuing to set their sights on the next decades of growth for products such as Johnnie Walker, a product where Diageo began the next evolution of the extremely successful ‘Keep Walking’ campaign. Diageo appears to have a “clear commercial interest in, ensuring that our people, our suppliers, the communities around our operations, and society at large all thrive as a result of Diageo‘s business”. In my opinion the alcohol industry is an attractive sector and Diageo has the assets, scale and global reach to be successful.

Financial Ratios:

Looking at the financial ratios Diageo is not cheap. They have a current P/E of 19.1 and 19.9 over the past five years. That being said Diageo’s price seems more attractive compared to Brown Forman, Constellations and the rest of the industry.

Sin stocks generally emphasize stability with a solid dividend. Diageo poses as providing one of the most attractive dividends in the industry with dividends per share of 1.83 over the past 5 years. With the increased FCF and improved cash management expect to see the currently higher payout ratio decline.

Now when picking Diageo as my alcohol stock for my Sindex I had trouble making the decision. While overpriced, Brown Forman blows Diageo out of the vodka in ROA, ROI, and EPS growth. Diageo struggles in asset management compared to its competitors. Diageo’s average ROE has been higher for the past five years but has decreased by almost 13% since 2010 while Brown Forman’s has been increasing.

I must remain steadfast and sober when making my decision. Brown Forman is an exciting company and their leading brand Jack Daniels is set for continued growth. However, Diageo is a more rational play as the price is closer to its actual value while still having prospects to expand in North America, Europe and in emerging markets. Oh, and I’m a fan of Crown Royal.