Kraton Corp. /zigman2/quotes/200458705/composite KRA +7.70% isn’t in the S&P 500 — it’s in the S&P Small Cap 600 /zigman2/quotes/210599868/delayed SML +2.19% —but given the wide-range of industries that the specialty chemical company’s customers are from, investors should take note that the company said fundamental demand in China, Europe and North America “weakened notably” as the quarter progressed.
The company, which warned of a profit and cash flow shortfall, also said the more “broad-based global economic slowdown” isn’t likely to reverse course for the rest of the year.
Kraton’s mention of North America, as well as recent data showing a contraction in manufacturing activity, suggests the overseas weakness is starting to hit the U.S. shores.
Tools and manufacturing supplies maker Fastenal Co. /zigman2/quotes/206312496/composite FAST -0.16% , which generates nearly 90% of its revenue in the U.S., according to FactSet, said the “general slowing” in economic activity it witnessed during the second quarter continued into the third quarter.
The U.S. economy’s strength relative to the economies of Europe and China has helped keep investment in the U.S. more attractive, which in turn has helped boost the dollar’s value relative to the currencies of its major trading partners.
While that might help lower the cost of imports, it also reduces the value of corporate sales and profits from overseas operations.
Considering that nearly 40% of the S&P 500 companies’ revenue comes from overseas, according to FactSet, a strong dollar could have a meaningful impact on financial results.
The average daily price of the ICE U.S. Dollar Index, which measures the buck against a basket of six major rivals, was 97.97 during the third quarter, up 3.2% from the daily average during the same period a year ago. More specifically, the dollar strengthened by 4.2% versus the euro and 2.5% versus the Chinese renminbi.
But considering how the pace of dollar gains has slowed, after rising 5.0% during the second quarter, investors should watch out for companies that put too heavy a blame on currency moves, in order to deflect attention from weakness resulting from fundamental reasons.
Oracle Corp. /zigman2/quotes/202180826/composite ORCL -0.24% said currency moves, which were “modestly more than expected,” widened the decline in net income to 6% from 3% in its recent earnings, and trimmed revenue growth to flat from up 2%. Nike Inc. /zigman2/quotes/203439053/composite NKE +1.03% said currency translation cut revenue growth by 3 percentage points to 7% , while dollar strength shaved about 7 cents per share from Carnival Corp.’s /zigman2/quotes/202325446/composite CCL +10.84% earnings.
Companies are charging more and it’s working, so far
One of the key uncertainties surrounding the impact of tariffs was whether companies would eat the higher costs, pass them directly to consumers, or do both.
Investors should keep a close eye on what companies say about price and/or sales mix, which is another way of describing higher-and-lower priced products, and the impact on gross margins. Were sales boosted by increased demand or by higher prices, or were customers unwilling to pay more?
Results from some early reporters suggest customers have been willing to pay a little more.
Chief Executive Jeffrey Harmening of General Mills, which missed revenue expectations but beat on profit, said flat out that one reason behind its “good” profitability was “because of our pricing.”
PepsiCo Inc. /zigman2/quotes/208744353/composite PEP +1.32% said “ effective net pricing ” accounted for all of the growth in fiscal third-quarter revenue, as volume was flat. The company defined effective net pricing as “discrete pricing actions, sales incentives and mix resulting from selling varying products in different package sizes and in different countries.” Read more about PepsiCo’s earnings.
Constellation Brands Inc. /zigman2/quotes/207737284/composite STZ +1.39% said pricing was “favorable” for operating margin, and Paychex Inc. /zigman2/quotes/202030365/composite PAYX +0.58% revenue per client improved as a result of price increases.
Fastenal reported Friday third-quarter profit and sales that rose above expectations. The company said that while “higher product pricing” helped lift sales for the quarter, gross margin fell to 47.2% from 48.1%, as sales growth occurred in lower margin products and cost inflation took a bite.
Meanwhile, FedEx has yet to pass on increased costs to its customers, as the company isn’t raising prices for ground and home delivery by 4.9% and for freight shipping by 5.9% until Jan. 6.
It’s holiday time again
The third-quarter reports will also offer the first glimpse at how the holiday season is faring, along with expectations and forecasts from retailers and consumer goods companies, along with big tech and others.
Experts are overall bullish about growth during this key shopping season, but as global consulting firm AlixPartners and the National Retail Federation (NRF) agree, the uncertainty about trade, tariffs and interest rates, are all factors that will impact shoppers’ confidence to spend freely on holiday gifts and gatherings.
“’Unprecendented uncertainty’ might be the best term to use to characterize this upcoming holiday season,” said Joel Bines, global co-leader of the AlixPartners retail practice, in a statement.
AlixPartners is expecting holiday sales to grow 4.4% to 5.3% while the NRF is expecting 3.8% to 4.2%.
Companies are unsure how things will pan out. When asked for a “temperature check” on the consumer during the most recent earnings call, Richard Galanti, Costco Wholesale Corp.’s /zigman2/quotes/201191698/composite COST +0.21% chief financial officer, spoke to the lack of clarity about the months ahead.
“[W]e’re still seeing good growth, certainly very good renewal rates, good results at openings, so we feel free good about it,” he said, according to a FactSet transcript. “Now if you ask me how does that relate to the consumer, who the heck knows.”
Still, while the lack of clarity is creating queasiness, factors like low unemployment rates and higher wages are positives. And the strategies and investments that retailers have put in place over recent quarters to strengthen both their e-commerce and bricks-and-mortar businesses are showing results. Retail sales grew more than 4% year-over-year according to U.S. Commerce Department numbers released last month.
“We continue to believe that despite the challenging and highly competitive retail environment, total retail sales will grow around 4% in 2019, driven by strong topline growth for larger, well capitalized retailers with strong e-commerce capabilities and for retailers that offer a compelling value and convenience proposition to consumers,” said Mickey Chadha, Moody’s vice president, in a note.