Is BlackRock's $12 Billion GIP Deal a Golden Buying Opportunity?

Posted on by The INO.com Team

Giant private asset manager BlackRock, Inc.’s (BLK) CEO, Mr. Larry Fink, made a modest prediction recently that the global economy might be on the brink of an “infrastructure revolution.” This forecast was made in the wake of BLK’s largest acquisition announcement in over 15 years.

With an initiative to invest in and own infrastructure, BLK is seeking to accelerate growth by announcing its plan to purchase Global Infrastructure Partners for $12.5 billion.

New York-based GIP owns and controls companies in sectors like energy, transport, water, and waste. If the acquisition goes ahead, it will be BLK's largest since it procured Barclays’s asset management business in 2009.

GIP, led by Adebayo Ogunlesi, is considered the third-largest infrastructure investor worldwide, falling behind Macquarie in Australia and Brookfield in Canada. Its assets are quite diverse, ranging from Gatwick Airport to Melbourne’s Port.

The cash and stock transaction between these two investment manager titans is slated for completion in this year’s third quarter, pending federal antitrust approval in the U.S.

This assertive acquisition represents a significant strategic push by BLK into the alternative investment sector, further securing its position as a dominant player in global finance.

Most of GIP's ownership resides with its six founding partners, five of which, including Bayo Ogunlesi (the CEO), will be joining BLK. Consequently, Ogunlesi will be tasked with leading BLK’s forthcoming infrastructure group while also becoming a board member and resigning from his position as the key director at Goldman Sachs.

BLK is strategizing to develop its private market operations, which suggests faster growth and higher possible returns when compared to its core business of trading down-priced passive investment products like exchange-traded funds. This deal will likely augment BLK’s private assets by roughly 30% and double the baseline management fees for its private markets.

With GIP, BLK is purchasing an infrastructure fund manager that manages around $100 billion, with a combined revenue of $80 billion from its portfolio companies.

After finalizing this acquisition, BLK aims to establish a separate Global Infrastructure Partners entity that melds the newly acquired firm with current BLK infrastructure teams.

The newly formed entity is projected to rank as the second-largest private infrastructure manager on a global scale, boasting over $150 billion worth of assets under its management – Brookfield Asset Management being the only firm outpacing this figure.

With government deficits on the rise, the demand for private financing for large-scale infrastructure projects has grown, and attractive investment subsidies may be key to meeting this need.

BLK's CFO, Martin Small, expressed that BLK's preference for acquiring GIP over opting for a traditional private equity buyout firm stems partially from the perception that the era of peak returns from private equity, facilitated by zero interest rates, might be on the decline.

BLK holds investments in several GIP funds, and there has been considerable competition for deals between the two entities. As Larry Fink propelled BLK to prominence in the field of traditional asset management, Adebayo Ogunlesi rose to head Credit Suisse's investment banking and fostered GIP in 2006 with his pool of fellow alumni from the now-defunct bank, who will also join BLK.

Acquiring GIP will promptly double BLK's management fees from private markets, highlighting that Fink appears to have found the prominent deal he has been seeking.

Nevertheless, BLK, as a publicly traded asset manager, faces the necessity to delicately balance the retention and motivation of GIP's top talent with the interests of its shareholders.

As part of striking a balance, it was decided that BLK would receive all the management fees on GIP funds in addition to 40% of the performance fees accruing from all future funds. GIP employees would retain all the carried interest in its existing funds and those slated for future raising.

To acquire GIP, BLK agreed to an amount of $3 billion in cash and 12 million of its shares, approximately equating to around $9.5 billion.

GIP is predominantly owned by its six founding partners, who will collectively ascend to become some of BLK's most significant shareholders, possessing about 8% of its outstanding shares.

BLK intends to distribute 7 million shares to the six GIP founders immediately and will add 5 million more in five years. A portion of this equity will be allocated to employees as a part of a retention strategy. As a result, the collective GIP team will ascend as the second-largest shareholder in BLK, binding them to the ongoing fortunes of their new proprietor.

But why is BLK pouring billions on infrastructure?

The evolution of the intervention of private investors in infrastructure began during the 1990s and early 2000s. Western governments burdened with mounting debts sought private investors to purchase and overhaul outdated infrastructure, from airports to water pipelines. Subsequently, numerous companies across industries, from energy providers to telecom operators, started selling assets such as pipelines and cell towers to these investors.

Presently, the demand for infrastructure investment is escalating, fueled by three significant trends:

  1. Decarbonization: In order to achieve global climate objectives, approximately $8 trillion is required to be spent on developing renewable energy infrastructure, storage batteries and transmission lines within this decade. Significant investments are also needed in hydrogen facilities to manufacture carbon-free fuel for aviation and maritime transport and in carbon capture technology.
  2. Digitization: While the software is increasingly dominating the world, it relies heavily on tangible assets, including fiber-optic cables, 5G networks, and data centers.
  3. Deglobalization: A shift in supply chains away from China has spurred demand for capital-intensive factories and new transport infrastructure to facilitate overland and sea freight movement. This trend has been further galvanized by increased calls for energy security in Europe following Russia's incursion into Ukraine, stimulating the construction of liquefied natural gas terminals to import fuel from less aggressive nations.

This skyrocketing demand for investment coincides with an era where government and corporate balance sheets are under significant stress. America's federal debt, nearing $34 trillion, is projected to continue snowballing throughout the following years. Additionally, several European governments face daunting debt burdens.

Rising interest rates have made these liabilities more burdensome to service and pose challenges to corporations that have capitalized on inexpensive debt to boost shareholder yields. Consequently, their capacity to finance substantial investments will be curtailed in the ensuing years. As a result, infrastructure investors are set to bridge this gap, having expressed their readiness and willingness to invest heavily.

Private equity groups anticipate growing their footprints in sectors like debt or infrastructure investment – sectors that are expected to profit from higher interest rates – either by incorporating public shareholders or merging with larger organizations. This approach extends beyond merely corporate buyouts, an area experiencing deceleration due to soaring financing costs.

The swift surge in interest rates has instilled caution among many investors, tempering commitment to fresh funds and stunting the utilization of existing ones. These prevailing circumstances present compelling reasons for independent firms to contemplate seeking out more substantial partners.

Fund managers hoping to benefit from the predicted influx of wealth from affluent individuals into private markets must heavily invest in novel products and distribution networks. Additionally, significant financial input into technology is essential to adapt to the advances in artificial intelligence.

The acquisition potentially furnishes BLK with a strategy to broaden its investment portfolio, thereby decreasing its vulnerability to market volatility. This is mainly due to the generally lower correlation that infrastructure investments bear with divergent asset classes and their reduced sensitivity to economic fluctuations.

Moreover, availing BLK of a comprehensive array of infrastructure assets could confer it with significant advantages. These mostly stem from those assets' capacity for long-term growth potential coupled with steady cash flows.

Following the acquisition, BLK is poised to emerge as a global leader, offering eminent infrastructure capabilities to its clientele. Clients who are persistently scouting for assets to counterbalance their extensive liabilities and diversify their portfolios may find solace in BLK's offerings.

Especially factoring in the prevailing economic conditions, this acquisition could prove to be a significant milestone for BLK. It would empower the company to effectively utilize its combined platform to capture a larger slice of the market share, churn superior returns, and seamlessly address the growing challenges and demands of its clients amidst the swiftly transforming infrastructure landscape.

Bottom Line

Throughout 2023 and well into 2024, two key trends have emerged within the financial sector: the escalating importance of private capital for infrastructure projects and the growing appeal of infrastructure assets amid economic uncertainty.

The recent landmark deal acts as a quintessential example of the consolidation trend that industry insiders have been forecasting. BLK has strategically secured a robust position in a market valued at $1 trillion today. Moreover, infrastructure is projected to be one of the most rapidly expanding segments of private markets in the foreseeable future.

While some caution against possible cultural discrepancies and potential conflicts of interest, the early market response to the deal appears stable. Shares of BLK surged by 1.3% immediately after the announcement.

Mr. Fink maintains his belief that the driving force behind their acquisition strategy has always been growth. With the acquisition of GIP, he firmly believes a similar scenario will likely play out. The efficacy of Mr. Fink’s belief is pertinent not just for BLK's shareholders but also for the entire industry that has billions invested in this premise.

The main query for BLK is whether this deal will finally serve as the key to unlocking a sector where it has previously found it challenging to gain substantial traction.

Besides the acquisition, there are numerous factors investors should consider during their assessment of the company. However, it might be prudent for them to wait and assess how this deal plays out.

Therefore, keeping BLK on the watchlist might be prudent at this juncture.

Joann Stores on the Brink: Is it Time to Unload JOAN Stock?

Posted on by The INO.com Team

Over the past years, the retail sector has been shaken by renowned names going under and a couple of others just barely surviving. In most cases, the financial damage was caused by the COVID-19 pandemic, which forced many retail businesses to shut down for months due to mandated stay-at-home orders.

Due to these closures, online retailers received a boost in sales as customers looked for alternative ways to shop.

JOANN, Inc. (JOAN), a specialty retailer of crafts and fabrics, should have been a pandemic winner, but it stands on the verge of collapse, and the company prospects appear weak, as per Creditsafe Head of Brand Ragini Bhalla.

In theory, JOAN should have benefitted from people staying at home during the pandemic, as sewing enthusiasts and other hobbyists make up the retailer’s customer base. Even when Joann stores were opened, customers could’ve opted to purchase their supplies online.

The ease of shopping online has changed customer behavior drastically, and that could have shifted some of Joann’s regular customers to e-commerce giant Amazon.com, Inc. (AMZN). Another possibility could be that some of the company’s fanbase died or changed their hobbies during the pandemic.

No matter what the reason is, Ragini Bhalla thinks that JOAN’s situation is critical.

“Given the struggles JoAnn has had with cash flow, its inability to stay current with many of its bills, its declining sales in FY 2023, and its $1 billion debt load, our Creditsafe algorithm has classified the company as a high risk of becoming seriously delinquent on payments and could be headed for bankruptcy very soon. Without strong leadership (still no permanent CEO), it could be hard to right the ship,” he told TheStreet via email.

Bhalla further stated that JOAN has been lagging in paying its bills, something which often foreshadows a bankruptcy filing.

“Creditsafe data shows that Joann struggled to make on-time payments in the second half of 2023. For most of that time, about 20% to 31% of its bills were paid late (1-30 days), while about 1% to 8% of its bills were paid late (31-60 days),” he added.

Despite management’s positive comments during the third-quarter 2024 earnings call, Bhalla sees the company’s risk of bankruptcy rising.

“Joann is rated as a high risk: Based on Creditsafe’s risk algorithm which takes into account both trade payment data and financial results, JoAnn is deemed to be a high risk (D), meaning it could be at risk of bankruptcy. Its risk score dropped from C to D in July 2023 and has stayed there since,” he added. 

Now, let’s discuss some of the factors that contribute to Joann’s precarious financial situation and could impact the stock’s performance in the near term:

Broader Challenges Faced by the Retail Industry

Over the past few years, several retailers have been grappling with struggling physical storefronts, massive debt, and inefficient operations, among other challenges. The COVID-19 pandemic initially compounded these issues and advanced the downfall of various retailers, which had faced declining sales and increasing debt in the years prior as consumer preferences changed.

Shopping centers witnessed decreasing foot traffic even before the pandemic, but stay-at-home orders further shifted consumers to online shopping and spending cash on essential goods instead.

After 2020, the retail industry experienced a major rebound as consumers returned to physical stores. While there were 52 retail bankruptcies in 2020, 2021 witnessed just 21, a decline of 60% year-over-year, according to the report by Axios, citing research by S&P Global Market Intelligence. In 2022, only a few retail companies went under.

However, last year, retail bankruptcies flared up again due to persistently high inflation and a significant pullback in consumer spending. According to Axios, there were about 82 bankruptcies filed by consumer discretionary companies amid a tighter financing market and higher borrowing costs.

Home goods and furniture retailer Bed Bath & Beyond filed for bankruptcy in April 2023. During the pandemic, the retailer’s merchandise was non-essential. A failure to take online shopping seriously harmed the company, and then product missteps and misguided financial maneuvers fastened its decline.

A popular Ohio-based fabric and craft retailer, JOAN, has been recently identified as having an elevated risk of filing for bankruptcy. It faces enhanced financial uncertainty after dwindling sales and massive debt. Also, the company seems to miss out on the e-commerce boom.

During the third quarter of 2023, the share of e-commerce in total U.S. sales amounted to 15.6%, an increase from the prior quarter. From July to September last year, retail e-commerce sales in the U.S. reached nearly $284 billion, the highest quarterly revenue in history.

Deteriorating Last Reported Financials

For the fiscal 2024 third quarter that ended October 28, 2023, JOAN reported net sales of $539.80 million, beating analysts’ estimate of $547.20 million. That compared to the revenue of $562.80 million in the same quarter of 2022. Its net interest expense increased 56.9% from the year-ago value to $28.40 million. Its adjusted gross profit was $282.10 million, down 5.8% year-over-year.

The company’s operating loss widened by 24.4% from the prior year’s quarter to $15.40 million. Its adjusted EBITDA declined 6.7% year-over-year to $37.50 million. Its adjusted net loss came in at $8.80 million, compared to an adjusted net income of $2.30 million in the previous year’s period.

Joann posted third-quarter adjusted loss per share of $0.21, compared to adjusted income per share of $0.06 in the same quarter of 2022.

Furthermore, for the nine months ended October 28, 2023, the company’s free cash flow decreased 26.4% year-over-year to $187 million. JOAN’s current assets were $790.30 million as of October 28, 2023, compared to $854.10 million as of October 29, 2022. Its net long-term debt stood at $1.15 billion versus $1.06 billion as of October 29, 2022.

Full Year 2024 Outlook

Despite deteriorating financial health, Joann’s interim leaders tried to paint a positive picture.

Commenting on the third-quarter performance, Scott Sekella, JOANN’s Chief Financial Officer and co-lead of the Interim Office of the CEO, said, “During the quarter, we continued to execute against our Focus, Simplify and Grow cost reduction initiative in which we had previously identified $200 million of targeted annual cost savings across supply chain, product, and SG&A expenses. As we implement these cost savings initiatives, we are driving meaningful cash flow improvements that we expect will continue for the remainder of this fiscal year and beyond.”

“With the strategic shifts we have implemented this year, combined with our ongoing cost reduction strategies, we are pleased to increase the top-line and reaffirm the bottom line full-year outlook,” Sekella added.

These management’s comments sound nice, but with only $28.30 million in cash and cash equivalents as of October 28, 2023, and its net long-term debt standing at $1.15 billion, the company has to make choices more carefully moving forward.

Unfavorable Consensus Earnings Expectations

Street expects JOAN’s revenue for the fiscal year (ending January 2024) to decrease 1.7% year-over-year to $2.18 billion. The company’s loss per share for the ongoing year is expected to widen by 149.4% year-over-year to $2.12. In addition, the company has missed the consensus EPS estimates in three of the trailing four quarters.

For the fiscal year 2025, the retailer’s revenue is estimated to decline 1.4% year-over-year to $2.15 billion. Analysts expect Joann to report a loss per share of $1.39 for the following year.

Declining Profitability

JOAN’s trailing-12-month EBITDA margin and net income margin of negative 1.51% and negative 11.10% compared to the respective industry averages of 11.04% and 4.56%. The stock’s trailing-12-month levered FCF margin of negative 1.68% compared to the 5.40% industry average.

In addition, the stock’s trailing-12-month ROTC and ROTA of negative 3.52% and negative 10.64% compared unfavorably to industry averages of 6.17% and 4.01%, respectively. Its trailing-12-month CAPEX/Sales of 2.43% is 19.6% lower than the 3.02% industry average.

JOAN’s FRISK Rating Lowered

Joann has been identified as at an increased risk of bankruptcy within the next 12 months by a retail industry analysis reported by RetailDive. In October 2023, JOAN got its CreditRiskMonitor FRISK Score updated, which generally has a 96% accuracy in predicting bankruptcies for public U.S. companies.

 In the report, Joann has been given a score of 1, which is the worst possible score. This indicates a probability between 9.99% and 50% of bankruptcy within the next 12 months.

Experts Hinting at Significant Bankruptcy Risk

“Joann is in a financial mess. Not only does it have a huge debt pile and associated interest, it is not profitable at operating level,” GlobalData Managing Director Neil Saunders posted on Retailwire.

According to Aptos’ Vice President, JOAN needs to make changes quickly to save itself and can look at a key competitor for ideas.

“Michael’s recently invested in revamping stores, streamlining checkout, upping their loyalty game,” she stated. “Joann would definitely benefit, and potentially quickly, by taking a look at their promotional strategy. It’s very confusing and there is a lot of over-promoting and overlapping promotions. Barring anything else, getting smart and streamlined and simple about the offer to customers could help both top and bottom line – at the same time.”

Further, CEO of Vector Textiles, Mark Self, said, “A specialty store specializing in crafts and sewing whose customer base is dwindling, no CEO and $1B in debt...sounds like liquidation time to me.”

Bottom Line

JOAN’s financial struggles continue as the retailer reported a sales decline and mounting losses in the third quarter of the fiscal year 2024. Stubborn inflation, continued supply chain disruption, a pullback in consumer spending, and macroeconomic uncertainty have impacted the company’s financial performance over the past year. Also, Joann has been slow to adopt e-commerce.

The craft and fabric company, which is still operating without a permanent CEO, tried to paint a positive picture about its growth prospects; however, Joann’s growing losses, massive debt and limited available cash tell a different story.

Companies rarely come out and tell investors that they are teetering on the edge of disaster until they are left with no choice. For instance, J.C. Penney, which spiraled toward bankruptcy, a fall that took years, the company’s earnings call mainly focused on positive aspects.

Given its deteriorating financials and other challenges, JOAN has its CreditRiskMonitor FRISK Score lowered to 1. Based on the history, companies that receive a 1 have between a 9.99% and 50% chance of filing for bankruptcy. Several experts further hinted that the company was facing significant bankruptcy risk.

With these factors in mind, it could be wise for investors to avoid JOAN’s shares now. 

Google's Workforce Shake-Up: Is the Quiet Layoff a Warning Sign for Investors?

Posted on by The INO.com Team

The New Year has just begun, and thousands of technology and startup employees find themselves unemployed. Layoff monitoring website, Layoffs.fyi, reports that by January 17, some 51 technology firms had terminated the employment of 7,528 individuals.

These terminations imply that 2024 might bring more hardships for the tech sector, following massive layoffs in the preceding year when over 1,150 tech companies laid off over 260,000 employees in 2023.

Alphabet Inc.’s (GOOGL) Google is reducing its workforce, dispensing with several team members from their digital assistant, hardware, and engineering sectors, as stated by the company.

A spokesperson from Google said, “Throughout the second half of 2023, a number of our teams made changes to become more efficient and work better, and to align their resources to their biggest product priorities. Some teams are continuing to make these kinds of organizational changes, which include some role eliminations globally.”

Affected staff include those associated with the voice-activated Google Assistant and the augmented reality hardware team. Additionally, professionals within the central engineering department are also bearing the brunt of these layoffs.

The initial layoff reports concerning the Google Assistant team came from Semafor, while 9to5 Google reported the structural changes affecting the hardware team first. Notifications of the termination have been sent to the involved staff members, with the opportunity extended to them to apply for other open positions within Google.

However, the Alphabet Workers Union, representing a portion of its workforce, has voiced displeasure over these job cuts. The union claimed that it was unethical of GOOGL to continue with the layoffs, especially during a period of significant profit growth for the company. For reference, the tech giant made $76.69 billion in revenues during the third quarter of 2023, recording a net income of $19.69 billion.

Google CEO Sundar Pichai told employees to anticipate more job cuts throughout the year. He further disclosed that the downsizing efforts for the current fiscal year are aimed primarily at eradicating complex levels to streamline execution and accelerate momentum in some areas. The move adds to signs that staff reductions will continue this year as numerous corporates proactively adopt AI and automation solutions to potentiate their operational efficiency.

But why direct resources to AI?

In 2023, GOOGL shares made a dramatic comeback, rocketing by an impressive 54%. This uptick marked a drastic shift from its disappointing 2022 performance, which saw the stock tumble by 39%.

The previous downswing was mainly triggered by a bear market, which severely impacted GOOGL's primary revenue source: digital advertising. With the marketing budgets reduced to preserve financial health during harsh economic conditions, many companies cut back on ad spending, causing a significant drop in GOOGL's year-over-year revenue. As a frontrunner in the online advertising landscape, GOOGL's performance was particularly negatively affected.

However, with the economy rallying back in 2023, companies were more generous with their advertising budgets, prompting a rebound in spending that benefitted GOOGL. That said, it was the technological leaps in AI that truly catalyzed GOOGL's renaissance.

While AI has been on the tech horizon for several years, GOOGL has successfully harnessed this technology to enhance the precision and applicability of its search engine, target digital advertisements, and streamline controls for its Waymo self-driving vehicles.

The advances in GenAI have opened new avenues of opportunity for GOOGL. GenAI is equipped to generate unique content, concise email replies, craft presentations, obtain relevant data from the internet and company databases, and even articulate and debug computer code.

GOOGL's strategic investment in AI and GenAI fuels innovation and augments development for its suite of products and services, including Google Search, Assistant, Cloud, and Workspace.

Directing resources to AI could support the enhancement and expansion of GOOGL's emerging functionalities. Moreover, GOOGL is committing to GenAI to develop revolutionary platforms and tools, like Google AI Studio and Bard that empower developers and users to modify and harness robust AI architectures.

This proactive move also aims to elevate and broaden the realm of AI R&D and fore-front discussions on the ethical and societal implications of AI technology.

What could be the probable impacts of the layoffs?

On a positive note, the impending layoffs at GOOGL have the potential to decrease operating expenses, secure considerable savings, and enhance earnings per share. This could also facilitate GOOGL's increased focus on AI, a critical factor for future growth and attaining competitive leverage.

Conversely, these layoffs pose a risk to GOOGL's innovative potential and capacity to retain talent. The company has garnered acclaim for its unprecedented and multifarious projects that necessitate significant investment and experimentation.

Moreover, these projects create valuable patterns of intellectual property and potential innovations. The workforce reduction may impede GOOGL's long-term objectives and creative potency. It risks tarnishing the brand's reputation as a preferred employer, making it challenging to entice and retain top-notch talent within the industry.

Layoffs can potentially diminish a firm's competitive advantage – conveying a message of weakness or instability to consumers, investors, and rivals. Furthermore, they may pave the way for newcomers or startups who can employ those made redundant or exploit market gaps.

Ultimately, the aftermath of the layoffs is contingent upon GOOGL's ability to navigate the transition effectively while harmonizing its short-term deliverables with long-term aspirations.

For the fiscal first quarter ending March 2024, GOOGL’s revenue and EPS are expected to increase 12.5% and 26.5% year-over-year to $78.48 billion and $1.48, respectively.

Wall Street analysts expect the stock to reach $155.91 in the next 12 months, indicating a potential upside of 8.4%. The price target ranges from a low of $140 to a high of $180.

Bottom Line

While the continued improvement of the economy has worked in GOOGL’s favor, it is the company’s increased interest in AI that has captured investors' attention. The anticipated outcome of this venture, particularly the positioning of Gemini Ultra in comparison to competing brands, remains uncertain.

However, as AI and Language Model (LM) technologies are becoming increasingly ubiquitous, companies successfully implementing these into specialized enterprise verticals for productivity and service enhancements are poised to emerge as leaders. GOOGL is ideally positioned due to its ability to integrate these technologies intensively across myriad business verticals.

Concerns, nevertheless, persist. Reduction in search market share, a core revenue stream for GOOGL, is one such issue. An offsetting strategy could be advanced monetization techniques of emerging developments expected to supersede the search paradigm. Given their broad-based customer (individual and enterprise) network, the potential for effective monetization is promising.

Culture, though, is another concern. Critics have cast doubt on the sustainability of GOOGL's innovative ethos, arguing that as a company grows becoming more bureaucratic, its innovative drive dwindles. A shift from a startup-oriented innovative approach, coupled with financial engineering strategies aimed at appeasing shareholders (including share buybacks) and the departure of employees, may have catalyzed cultural shifts. Notably, GOOGL has endured an exodus of talent into startup ventures and might witness more of it because of additional layoffs.

Beyond affecting employees and their families, layoffs can have a negative long-term impact on a company's performance. Investor confidence in a company’s ‘going concern’ has a direct correlation to its share price.

Although there may be temporary upward spikes in share prices following job cuts, this usually reverses when unemployment surges, leading to a market recession.

Given these factors, investors might find it prudent to place GOOGL on their watchlist, awaiting an opportune moment for investment.

Investor Concerns Rise as Tesla Slashes Prices in China: Sell or Hold?

Posted on by The INO.com Team

China’s electric vehicle (EV) stocks started the new year on the wrong foot, as heightened competition and continued price wars pressurized the profitability of automakers.

Morgan Stanley highlighted growing competition concerns in its note: “Investors remain cautious as China’s auto market has had a volatile start to the year as competition and macro uncertainties persist.”

Also, in a report on the Chinese EV industry earlier this month, Bernstein analysts said, “We expect competition within the domestic market to remain intense and put pressure on pricing and profitability.”

There are too many automakers fighting for EV market share in China. Tesla, Inc. (TSLA) has slashed the prices of its Shanghai-made vehicles by up to 6% in a strategic move to maintain its leading position in the premium segment of the world’s largest EV market.

The Texas-based company recently announced that the base version of the Model Y crossover vehicle starts at nearly $36,000, a decline from about $37,000. The base Model 3 now starts at about $34,500, down from $36,500.

Tesla has cut prices aggressively across its markets worldwide since late 2022 due to higher interest rates, a period of uneconomic certainty, shifting consumer sentiment, and intense competition.

For instance, a U.S. rear-wheel drive Model 3 began at approximately $47,000 in 2022. Its price was cut to about $44,000 in January 2023 and $40,000 following a price cut in April. After one more cut in October, the price of a new U.S. Model 3 ended 2023 at about $39,000.

The recent price cuts in China by Tesla will fuel more fears about competition and profit margins among investors.

Shares of TSLA have plunged more than 7% over the past month and nearly 19% over the past six months.

Now, let’s discuss several other factors that could impact TSLA’s performance in the upcoming months:

Quarterly Deliveries and Production Beat Estimates

Tesla delivered nearly 484,000 vehicles in the fourth quarter, surpassing analyst expectations of 483,173, as compiled by Bloomberg. The company produced 494,989 vehicles, beating the consensus estimate of 482,336. For the full year 2023, the Elon Musk-led automaker reported deliveries of 1.81 million and production of 1.85 million, representing growth of 38% and 35% year-over-year, respectively.

The company delivered 461,538 Model 3 and Model Y vehicles during the fourth quarter and reported production of 461,538 for these models. TSLA didn’t break down Model S or X production or delivery numbers, instead batched them into “Other Models.” It delivered 22,969 other models and produced 18,212 vehicles for the quarter.

In 2022, TSLA reported annual deliveries of 1.31 million and production of 1.37 million vehicles, a nearly 40% increase from 2021.

During the last earnings call held in October 2023, TSLA’s management said that the company would hit at least 1.8 million deliveries for the full year, a number they had revised down from a 2 million target earlier.

Dethroned as the EV Global King

Chinese automaker BYD Co. (BYDDY) reported that it delivered 526,409 fully electric cars during the fourth quarter, topping TSLA for the first time. China’s top-selling car brand reported EV and hybrid sales of 341,043 in December 2023, including 190,754 all-electric cars, aided by aggressive year-of-year discounting. In total, BYD sold 3.01 million vehicles in 2023.

Moreover, BYD produced more than 3 million new electric vehicles in 2023, beating TSLA’s production for a second consecutive year.

Disappointing Last Reported Financials

In the third quarter that ended September 30, 2023, TSLA posted revenue of $23.35 billion, missing analysts’ estimates of $24.14 billion. Its gross profit decreased 22.4% year-over-year to $4.18 billion. The company’s operating expenses increased 42.5% year-over-year to $2.41 billion.

Musk-led EV maker reported income from operations of $1.76 billion, down 52.2% from the prior year’s period. Its adjusted EBITDA declined 24.4% year-over-year to $3.76 billion. The automaker’s adjusted net income attributable to common stockholders decreased 36.6% from the previous year’s quarter to $2.32 billion.

Furthermore, the company reported an adjusted EPS of $0.66 for the third quarter, below the consensus estimate of $0.73. That compared to $1.05 in the same quarter of 2022.

Tesla’s net cash provided by operating activities was $3.31 billion, down 35.1% year-over-year. Its free cash flow decreased 74.3% from the year-ago value to $848 million.

Unfavorable Analyst Estimates

Analysts expect TSLA’s revenue for the fourth quarter (ended December 2023) to increase 6% year-over-year to $25.76 billion. However, the consensus EPS estimate of $0.73 for the same period reflects a 38.3% year-over-year decline. In addition, the company has missed the consensus revenue estimates in three of the trailing four quarters.

For the fiscal year 2023, the company’s EPS is expected to decrease 21.8% year-over-year to $3.18. Street expects the automaker’s EPS to decline 4.6% year-over-year to $0.81 for the first quarter ending March 2024.

Suspension of Production at German Factory

According to Reuters, Tesla plans to suspend most production at its factory outside Berlin in Grunheide, Germany, from around January 29 to February 11 due to the ongoing conflict in the Red Sea that has disrupted global trade.

“The considerably longer transportation times are creating a gap in supply chains,” Tesla told Reuters in a statement.

Analysts at Baird estimate Tesla produces between 5,000 vehicles and 7,000 vehicles per week at its Berlin factory. The shutdown of this vehicle assembly plant in Germany would result in a 10,000-14,000 hit to deliveries in the first quarter of 2024, said analysts Ben Kallo and David Sunderland in a note.

The Baird analysts added that they are “wary” of further effects on the company’s supply chain, and they are “closely monitoring” any impact on its shipping routes from China.

Tesla EVs in Regulators’ Scrutiny

Moving into 2024, Tesla faces growing pressure from regulators. The auto giant faces a new investigation from regulators in Norway and Sweden after a Reuters report alleging that the company covered up defects and charged its customers for repairs that should have been under warranty.

In a statement to Reuters, Sweden’s Transport Agency confirmed “that investigative work is also underway with us” shortly after Norway’s traffic safety regulator launched its probe into reports of repeated suspension failures affecting Tesla models.

Norwegian Public Roads Administration (NPRA) senior engineer Tor-Ove Satren stated that the agency began questioning Tesla in September 2022 and asked the auto company to assess consumer complaints about lower rear control arms breaking on its Model S and X vehicles.

Satren added the agency could recommend that Tesla recall all model years of the S and X vehicles to replace rear lower control arms if it determines they pose a “serious risk.”

Concerns Surrounding Tesla’s Cybertruck

Experts raised safety concerns regarding the angular design of Tesla’s Cybertruck as the electric pickup truck’s stiff stainless-steel exoskeleton could hurt pedestrians and cyclists, damaging other vehicles on roads.

“The big problem there is if they really make the skin of the vehicle very stiff by using thick stainless steel, then when people hit their heads on it, it’s going to cause more damage to them,” said Adrian Lund, the former president of the Insurance Institute for Highway Safety (IIHS), whose vehicle crash tests are an industry standard.

Elon Musk earlier mentioned in Tesla’s third-quarter earnings call that the company was facing several challenges in scaling its production. He also cautioned that Cybertruck won’t deliver considerable positive cashflow for 12 to 18 months after production starts.

Musk said, “It is going to require immense work to reach volume production and be cashflow positive at a price that people can afford” with the Cybertruck. He added, “I just want to temper expectations for Cybertruck. It’s a great product, but financially, it will take a year to 18 months before it is a significant positive cash flow contributor.”

Elevated Valuation

In terms of forward non-GAAP P/E, TSLA is currently trading at 68.73x, 345.6% higher than the industry average of 15.42x. Likewise, the stock’s trailing-12-month EV/Sales and EV/EBITDA of 6.94x and 41x are significantly higher than the industry averages of 1.23x and 9.88x, respectively.

Additionally, the stock’s forward Price/Sales of 7.12x is 695.1% higher than the industry average of 0.89x. Its forward Price/Cash Flow multiple of 54.58 compares to the industry average of 9.88.

Decelerating Profitability

TSLA’s trailing-12-month EBITDA margin and net income margin of 15.80% and 11.21% are higher than the respective industry averages of 10.96% and 4.56%. However, the stock’s trailing-12-month gross profit margin of 19.81% is 44% lower than the 35.38% industry average.

Also, the stock’s trailing-12-month levered FCF margin of 1.68% is 68.9% lower than the industry average of 5.40%.

Bottom Line

TSLA has repeatedly cut prices in China and other global markets since late 2022, leading other automakers to respond and squeezing profit margins industry-wide. Several price cuts were made due to weakened demand amid higher interest rates and a period of economic uncertainty coupled with intense competition in the EV industry.

Following the decline of news that the company could suspend production at its Giga Berlin factory due to Red Sea-related supply disruptions, Tesla’s stock plunged further after the automaker announced new price cuts in China. These price cuts come as competition continues to get intense on the Chinese mainland.

Moreover, BYD has gone more upmarket, pushing into segments where TSLA operated and found success.

The automaker’s third-quarter revenue and earnings missed analysts’ estimates. Further, Wall Street appears bearish about TSLA’s outlook as the company grapples with several challenges, including supply disruptions, growing regulatory concerns, sliding margins due to price cuts, intense competition, and weakened consumer demand amid a high-interest rate environment.

In mainland China, passenger EV sales growth plunged to 28% in the third quarter of 2023 compared to 108% in the same period a year ago, as per China Association of Automobile Manufacturers data quoted by Fitch Ratings.

According to Fitch Ratings, the growth slowdown will get worse this year. “We expect China’s domestic passenger car demand to increase modestly in 2024 to nearly 22 million units amid economic uncertainty,” said Fitch Ratings.

Considering these factors, TSLA shares are best avoided now.

Quality Stocks In…Garbage Stocks Out!

Posted on by The INO.com Team

Please enjoy this updated version of weekly commentary from the Reitmeister Total Return newsletter. Steve Reitmeister is the CEO of StockNews.com and Editor of the Reitmeister Total Return.Click Here to learn more about Reitmeister Total Return

SPY – Stocks keep flirting with the all time highs for the S&P 500 (SPY) and keep falling short. Meaning this is proving to be a stubborn level of resistance at 4,800. Why is that happening? And when will stocks finally break above? 43 year investment veteran Steve Reitmeister shares his view including a preview of his favorite stock picks now. Read on below for the answers…

 

As suspected, the market is not ready to make new highs above 4,796 for the S&P 500 (SPY).

That was quite evident Thursday as stocks jumped out of bed in the morning to touch those previous highs only to find stubborn resistance with the broad market heading lower from there.

Why are stocks struggling at this level?

And what is an investor to do about it?

The answers to those vital questions will be at the heart of today’s commentary.

Market Commentary

Some investment writers will have a fairly short hand, and highly inaccurate, way to describe what happened on Thursday.

They will tell you that the CPI inflation reading was hotter than expected on Thursday morning. And that caused the stock market sell off that followed.

That is simply not true.

Here is what really happened. The CPI report came out an hour before the market open. And yet still the market leapt higher out of the gate. But once it touched the hem of the previous highs (4,796) a more than 1% intraday sell off that ensued.

That pain is not so evident in the late session bounce and modest loss for S&P 500. Yet is a lot more apparent in the -0.7% showing for the small caps in the Russell 2000 on the session.

Thus, the problem for lack of further stock advance is not about CPI report. Just a statement that investors are not prepared to breakthrough resistance to make new highs.

So, what is holding stocks back?

I discussed that in greater detail in my last commentary: When Will the Bull Market Run Again?

The essence of the story is that investors have less clarity on the next moves for the Fed than they had after the November and December meetings that sparked a tremendous end of year rally. Unfortunately, there has been a mixed bag of inflation and economic data that calls into question when rate cuts will begin.

At the earliest those cuts could come at the March 20th meeting. But I sense that the more readings we get like Thursday’s CPI report, or last Fridays stronger than expected employment report…the more likely those first cuts get pushed off to either the May 1st or June 12th Fed meetings.

Digging into the CPI reading we find that inflation was expected to come in at 3.1% yet spiked to 3.4% on this reading. Core CPI was even worse at 3.9% year over year. Just still too far away from the Fed’s target of 2%.

For the “wonks” out there you should dig into the Sticky Price resources created by the Atlanta Fed. To put it plainly, sticky inflation remains too sticky. The main elements are housing and wages that are not coming down as quickly as expected.

When you appreciate the conservative nature of the Fed…and that they state over and over again that they are “data dependent”, then its hard to look at the recent data and assume they are ready to lower rates any time soon.

Long story short, I don’t think that investors are ready for the next bull run to make new highs until they are more certain WHEN the Fed will finally start cutting rates. That delays the next upside move to March 20th at the earliest with May or June becoming all the more likely.

Hard to complain about settling into a trading range for a while given the tremendous pace of gains to end 2023. So this seems like a reasonable time for stocks to rest before making the next big move.

The upside of the current range connects with the aforementioned all time high of 4,796…but really easier to think of the lid as 4,800.

On the downside, that is a bit harder to infer. Typically trading ranges are 3-5% from top to bottom. So, for quick math let’s say around 4,600 on the bottom. This also represents the previous resistance point that took a long time to finally break above in early December.

The good news is that I expect quality stocks to prevail even in a range bound market. Meaning that last year pretty much any piece of beaten down junk was bid higher. That party is OVER!

Instead, when you have a pretty fully valued market as we have now, then there will be a greater eye towards quality of fundamentals and value proposition. I spelled that out pretty completely in last week’s article: Is 2024 Prime Time for Value Stocks?

The answer to the question posed in the headline is…YES. Meaning that 2024 is lining up nicely for value stocks.

Case in point being the early results this year with our Top 10 Value strategy up +3.70% through Wednesday’s close vs. breakeven for S&P 500 and -2.80% for the small caps in the Russell 2000.

I strongly believe that edge for value will continue as the year rolls on. And the best way to take advantage of that is spelled out in the next section…

What To Do Next?

Discover my current portfolio of value stocks packed to the brim with the outperforming benefits found in our exclusive POWR Ratings model.

This includes direct access to our Top 10 Value Stocks strategy that is hot out of the gates in 2024 with plenty more room to run.

If you are curious to learn more, and want to lean into my 43 years of investment experience, then please click the link below to get started now.

Steve Reitmeister’s Trading Plan & Top Picks >

Wishing you a world of investment success!


Steve Reitmeister
…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com & Editor, Reitmeister Total Return

SPY shares were trading at $475.88 per share on Friday afternoon, down $0.47 (-0.10%). Year-to-date, SPY has gained 0.12%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author

Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.