Inside the Madness

A Deeper Dive into Company Execution Amidst Macro 'Lens of Doom'

From: James Cramer
Sent: Thursday, November 03, 2011 2:20 PM
To: Nicole Urken
Subject: Wheat from chaff

We are seeing some companies facing identical sets of circumstances and some are hitting it out of the park while others are totally whiffing. Let’s gather these up. Re-send me the conference call and notes on Avon. Need to compare to Estee Lauder. Also, let me see Kellogg from today and recent notes on General Mills.

From: James Cramer
Sent: Thursday, November 03, 2011 2:22 PM
To: Nicole Urken
Subject: RIG

Also need Transocean. Comparing to Ensco

Nicole Urken, Mad Money Research Director

From: Nicole Urken
Sent: Thursday, November 03, 2011 2:24 PM
To: James Cramer
Subject: Re: RIG

All attached. We can also look at Core Labs (good) versus Baker Hughes (bad) in oil services

The 11-meter high sculpture of a middle finger by Maurizio Cattelan that has remained outside the Italian Stock Exchange in Milan captures the sentiment of frustration with the sovereign-level crisis, with Europe front and center.

A general view of Maurizio Cattelan's controversial statue on March 15, 2011 in Milan, Italy. The work L.O.V.E., located in front of the Milan Stock Exchange, depicts a hand with four severed fingers and the middle finger up.
Jacopo Raule | Getty Images

In fact, Europe continues to run the show in the US markets—so much so that when there are negative news headlines out of the region, they become a “lens of doom” through which to view our companies’ earnings reports—many of which have been strong. As we discussed in the top of Thursday’s "Mad Money" show, the brief reprieve from dismal-only news out of the region (with the positive development of a rate cut from “Super Mario” Draghi—the new President of the ECB) was what allowed the market to reward some of the strong earnings reports.

Friday, we’re back to looking at companies through the “lens of doom” with negative headlines out of the G-20 summit. (In the global game of “Deal or No Deal?” Friday was “No Deal.” And, uncertainty is no good for the markets).

Now because of the macro cloud, with a bit of tech excitement focused on the Groupon pop—a gain that should be locked in given competition and profitability concerns!—investors once again may be tempted not to focus on the fundamentals of the reporting companies. However, separating the wheat from the chaff is all the more important when the good get pushed down with the bad, as we discussed in Thursday's “no huddle” segment.

One important component, though, of recognizing the companies that have been able to execute versus those that have not, comes down to pricing.

Pricing power is key in the consumer staples, as we know—because it is the antidote to fending off rising costs. Case in point: Kraft . While Kraft noted growth in developing regions (benefits from Cadbury acquisition!), the KEY of their conference call was that they have been able to take the necessary pricing (up 7 percent) to offset increases in raw material costs. Ahead of the anticipated break-up of the company, Kraft has been able to change its tune from what had been a number of sequential disappointing reports. 

Now, the reason that Kellogg posted such a disappointment was that it was not able to take advantage of the pricing strength it did see (up 5 percent), as it was plagued by execution issues on the supply side. Ultimately, Kellogg’s turnaround (new management, better products, international growth) caught a hiccup as it was not able to take advantage of the pricing-boosted topline.

To illustrate the effect of pricing power, there is no better place to look than an extreme example: the tobacco stocks. Altria and Philip Morris have been able to serve as an attractive dividend yield plays versus wasting assets, despite volume declines in cigarette sales. Why? Because of their ability to continually raise prices. Few companies in the world have the pricing power of MO and PM because they are in an area where people will pay up (for better or for worse: addiction!) and of course have dominant market share with strong brands in the US and internationally, respectively.

In consumer discretionary, pricing power remains a key antidote to rising costs—something we’ve heard from the likes of Ralph Lauren and Macy’s which report next week (warning: expectations are high!)

In fact, pricing power has been one of the key reasons we had seen significant outperformance at Abercrombie & Fitch this past year, relative to Aeropostale and American Eagle . Abercrombie’s higher price points relative to the other two allowed it to be more of a fashion play that teens would pay up for … versus the latter two that had more competition over price and were more affected by rising input costs. Of course, the trends of the stocks were severely reversed yesterday, though, when Abercrombie’s international momentum thesis showed slowing and the Aeropostale/American Eagle teams demonstrated an ability to turn around the declining fundamentals and beat much-reduced expectations.

Less intuitively, another important component of pricing in addition to “pricing power” is “pricing integrity.” The reason behind the highlighted divergence in Core Labs , whose CEO came on "Mad Money" on October 19th after the typical post-release sell-off, and Baker Hughes comes down to the latter sacrificing their pricing (and thus margins) to win more business from its customers. As we saw when BHI reported on Tuesday, their international margins suffered. At a certain level, increasing the volume of business becomes negative if it’s done at a depressed level from a pricing standpoint. Weatherford had been a name in the oil services space with the least pricing integrity, but Baker Hughes’ latest report—with disappointing profitability—gives WFT a run for their money.

The bottom line: Pricing power and pricing integrity is key. When you are researching companies for “buys”, look for the ones that have them—the execution “winners” of late have been the ones that have captured it—like Core Labs and Kraft.


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