This article is authored by MOI Global instructor Jeff Auxier, president of Auxier Asset Management, based in Lake Oswego.
Jeff is an instructor at Best Ideas 2024.
Over the last several years, more companies have gone public with sky-high valuations, little-to-no profit and big promises of transforming their markets. When money was cheap it was easy for a new business to attract significant investment. Not so today as the spigot is shut off.
One company that fell victim to overhype is Beyond Meat which went public in May of 2019. The alternative meat company’s stock surged 163% on its first day of trading which at the time made it one of the best day-one performances for an IPO in nearly 20 years. JPMorgan originally estimated that Beyond Meat would be able to grow their sales to $5 billion in 15 years. The hope was that millions would abandon traditional meat for plant-based meat which was deemed to be more environmentally friendly and sustainable. After the IPO, the market consensus was for Beyond Meat to turn free cash flow positive by 2022 and have compound annual sales growth of around 40%. Instead sales fell 10% that year and they have yet to attain positive free cash flow even today. The company continues to struggle due to factors like its premium price and low availability. Since the stock’s all-time high in July of 2019, it has fallen over 95%.
Another more extreme example of a torpedo is WeWork. Its valuation ballooned to $47 billion in 2019 before crashing to less than $100 million today and it is closing in on bankruptcy. Euphoria surrounding the growth of electric vehicles led Rivian’s valuation to surpass $120 billion before the company reported even a single dollar in revenue. The company’s valuation has since fallen to under $16 billion.
The Robinhood trading app tried to capitalize on the massive IPO craze by going public in 2021 with a peak market cap of over $45 billion. Since then the stock has declined over 80% to a market cap of around $9 billion. Talk is cheap and the markets tend to eventually punish bad behavior.
Disruption in Weight Loss Drugs
New weight loss drugs have recently become increasingly popular; some are proclaiming them as the next big breakthrough in the health industry. These products, called GLP-1 agonists, work by making patients feel less hungry and can also affect how the body absorbs fat. Novo Nordisk and Eli Lilly are the two leaders in this new market which analysts at Goldman Sachs and JPMorgan estimate could reach $100 billion by 2030.
Some investors are concerned that these drugs will be so effective at curbing appetites that they could fundamentally change consumption patterns and impact demand for businesses like food and beverage companies. Investors worry that fast food restaurants already contending with rising inflation will also have to deal with a potential loss in customers if the use of weight loss drugs becomes more common. It is estimated that just over 42% of US adults are obese and could potentially be prescribed weight loss drugs.
Wall Street has been quick to herald these drugs as the ultimate healthcare product, but it is important to take a more cautious stance, especially in the early stages of research. There are still many unknowns surrounding these treatments, specifically around potential side effects like thyroid tumors, pancreatitis, diarrhea and nausea. It is expensive too, with an average monthly cost for shots of around $1000.
In the third quarter excitement over these drugs led to indiscriminate selling in food, beverage, medtech and medical devices to name a few examples. It is similar to the selloff in traditional food stocks when Beyond Meat went public as referenced earlier in the letter. McDonald’s believes there are currently about five million people using obesity drugs with the potential to increase to 15 million in the next few years, which they figure could hurt volumes by one half a percent. Pepsi and Starbucks have seen no change in demand year to date.
Energy was the best performing S&P 500 sector during the quarter, up 12.2%. Continued supply cuts by OPEC+ have kept oil prices elevated as the West Texas Intermediate (WTI) Crude rose by 29% in the third quarter. The US Energy Information Administration (EIA) expects that OPEC+ will keep production limited for the remainder of 2023 and into 2024. They forecast an average Brent Crude spot price of $91 per barrel in the fourth quarter and an average of $95 per barrel for 2024. The recent conflict in Israel has fueled fears over the stability of global oil markets as there are uncertainties around what countries like Iran will do in response to escalations. Iran is one of the largest producers of oil in the world and in August their output reached 3.1 million barrels per day, the highest since 2018 (Reuters). Potential Iranian involvement should lead the US to enforce stricter sanctions on the country’s oil exports. Iran also controls the Strait of Hormuz which is the most important oil checkpoint in the world, with around 20% of global oil supply passing through daily.
Insurance Hard Market
Property casualty stocks are enjoying a hard-pricing market. Global commercial insurance pricing increased for most lines of coverage in the third quarter, according to Marsh McLennan, marking the longest run of consecutive quarterly rate hikes since 2012. US property rates are up 14% for the quarter. Auto insurance rates are up 15.5%, with rates in Florida up 88% and electric vehicles up over 70%. Disciplined operators benefit from rising prices and rising premium volume. In addition, higher interest rates improve portfolio cash flows. The insurance component of the S&P 500 trades at 12 times next year’s earnings, a steep discount to the overall market. We have a wide exposure to the property casualty industry with names like Berkshire Hathaway, Travelers, AIG, Marsh McLennan, AON and Ryan. In addition, health-related insurers like Aflac, UnitedHealth and Elevance are seeing positive fundamentals in pricing and volume trends.
On a recent multistate trip we visited the new $40 billion Taiwan Semiconductor (TSMC) facility under construction in North Phoenix. The amount of cement required is straining supplies for the entire metro area. Over 60% of the workforce for that plant will have a masters or higher degree. This is just one of several plants going in as a result of the government CHIPS act. That roughly $52.7 billion stimulus has attracted another $200 billion in private funds which is just starting to filter through the economy. In addition, $433 billion of government spending is earmarked over the next 10 years under the Inflation Reduction Act. It is hard to see a recession in those industries related to such massive fiscal stimulus.
Most stocks and bonds have been in a grueling bear market for two years. More than half the Russell 3000 stocks are down over the past twelve months. Usually the last third of a bear market is a capitulation and the most painful. We are finally seeing attractive values in many businesses that have been experiencing multiple compression with tighter money, especially in smaller companies. Our biggest winners coming out of the 2000-2002 bear market were in smaller companies like Scottsdale credit card processor eFunds. It traded at a single digit p/e under $10, was debt free and ultimately acquired by private equity for over $37. During these challenging market conditions we strive to add value by mitigating risk through our cumulative knowledge and experience along with a ramped-up research effort. Our research centers on the earnings power and growing intrinsic value of the individual businesses we own. Longer term there is a direct correlation to the earnings and ultimate stock price return.