Dumbest Of Times
The election, a resurgence of the virus, and volatile markets have made for a stressful late October. Winter is coming; it doesn’t look all that fun. The twitter epidemiologists, political conspiracy theorists, stimulus failures, and whatnot need to be filtered out. It hasn’t been the October of Wisdom. Besides, Dickens characters tend to grow up and become boring.
Earnings season is always taxing but this season is particularly…dumb. Take ROL. That the company continued to function after the death of the Chairman is hardly surprising – baton passing underway! But control of the company - particularly after the other patriarch passes – that matters. The SEC opened an investigation disclosed in the 10-Q with no clarity on what they found, but accruals and reserves often fall into the ‘earnings management’ bucket. For a company that regularly engages in acquisition-led-growth, it raises concerns. The Board’s “Audit Committee retained independent counsel to conduct an internal investigation into matters related to the SEC investigation and, in particular, the Company’s processes for establishing reserves for each quarter in the relevant periods.” The Board apparently saw something, and that Board is not what we would call ‘really, really good looking & independent’. The ROL earnings report itself read okay, largely because gasoline prices were down in the quarter. Organic growth on the commercial side was negative 3.7% in the quarter and still negative in October per the call. Offsetting strength in residential looks to be fading. Apparently, that brew was good enough for a rally in shares that were already trading north of 70x earnings. Pest control is just not a growth industry.
The good news about earnings season in general? The correlation between a good earnings season and good quarterly alpha is, in my experience, weak to negative. The market is adjusting to numerous crosswinds, slipping from Quad 4 to Quad 3 amid significant economic and policy uncertainty. The market must be ‘wrong’ for a period for an ‘alpha opportunity’ to opening. Hopefully, that’s where we are.
Will there be another COVID stimulus package? If Republicans in the Senate wouldn’t give one to Trump right before an election, why would they give one to a new Biden administration? Rs could filibuster even in a Blue Wave scenario. Per our Macro Policy head JT, Senate Republicans are “suddenly setting themselves up to be deficit hawks for a potential Biden presidency”. Someone should send them the Kelton book! We’d keep everything on a short leash.
ROL | Residential Fade, SEC FUD
The Rollins 10-Q contained a notable new disclosure, discussed above.
Organic growth in the quarter is not the stuff of which multiple expansion is made.
It also looks like there was a surge of residential pest control interest in September – maybe mice and bugs entering as the weather turns & more people were at home to see it. That tailwind has subsequently faded.
The margin expansion in the quarter was driven by aggressive pricing (+3.5%) and lower expansion. That rate of price increase is unsustainable, in our view, and Orkin already has rich pricing relative to competitors.
With higher prices, ongoing commercial pressure, and signs of a normalization of residential volumes, ROL looks like difficult long here.
FCN | &%@#IING Mediocre Quarter, But That Isn’t The Point
We didn’t love the prepared remarks to the FTI Consulting call. It sounded like some sort of campaign speech. That doesn’t make it wrong, however. We see FCN as serving depressed markets, with antitrust, white collar enforcement, and restructuring depressed relative to more ‘normal’ levels. Consider a scenario where Senate Republicans don’t sign onto stimulus – restructuring activity would surge into January. Staffing levels are analogous to backlog in this industry and confirms that management expects stronger results in 2021…even if they won’t discuss them until February. Higher charge-offs, early lease exit charges, and other charges in the quarter position FCN for better results in coming quarters. Results are readily explained by that ‘taking pain now’ move, as well as cost loading on the staffing side.
Utilization in the Forensic & Litigation segment should improve as court activity normalizes.
Higher margins are likely heading into 2021.
If Tech antitrust enforcement gets off the ground – and it is a rare area of bipartisan agreement – this segment could emerge as a key growth driver into 2021.
We are either very late or a bit early in FCN. This specific downcycle isn’t ‘normal’ with PPP and bailouts of industries like airlines delaying some restructuring activity, court closures specific to the pandemic limiting activity, and antitrust/enforcement actions often delayed until after an election. We think we are early, and not very early at all. But the sell-off today makes us frustratingly wrong on FCN via an overreaction to a comparatively minor disappointment. Nothing reported was worthy of the decline the shares posted, from what we saw. Perhaps some traders were expecting a 3Q20 blow-out on the lack of a further COVID-19 package. If so, they are a quarter and a half too early. We’ll know much more in February…and perhaps by mid-November.
WAB | Mind The Gap To GAAP, Book-to-Bill Still Negative
Siri, can you make a sentence out of generic MBA/GE terms?
SIRI: “As we go forward, we remain committed to executing on our strategic plan, reducing costs, aggressively managing cash, delivering on our synergy targets and focusing on what we can control. We will continue to lean into the strong long-term fundamentals of this company and invest in technologies that advance our competitive advantage, help us successfully manage today's market headwinds over the long-term and emerge as a more resilient company.”
WAB is as late/long cycle as it gets (including commercial aerospace this round). For example, Transit aftermarket was down 10% while Original Equipment (OE) was down 2%. Who is adding capacity to transit systems? Mostly those who ordered BEFORE the pandemic. As those orders and backlogs work down, results should remain under pressure for an extended period. WAB is aggressively reducing debt. Perhaps they see the deep, prolonged downturn coming. That was our take on the timing of the Faiveley acquisition – positioning them for the Freight equipment downturn. Adding back the amortization expense for a deal as difficult as GET is, well, ‘difficult’ for us. When do those costs get recognized? WAB has had ample allocations to non-amortizing intangibles. And we’ll see restructuring and transaction charges until when? But these are arguments for a different day.
Book-to-Bills remain below 1 for both segments.
Negative organic growth in Freight starts with the adoption of PSR, not with the pandemic. PSR isn’t going away – equipment came out of CP for over 5 years as speeds increased.
Transit is challenged by the pandemic – we’ll see how long it lasts, but policy makers seem more interested in autonomous vehicles and electric charging for now.
Rail speeds – the primary means by which rails increase asset turns and reduce the need for rail equipment – was hit this quarter by storms and a snapback in volume. Speeds are picking back up in 4Q20. This is a key goal of PSR.
And if gasoline consumption is an indication, mobility is again declining as COVID-19 case counts return.
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EXP | Progress & Uncertainty
Both segments at Eagle performed better, and EXP is one of the longs we have in the housing/construction theme. The charts are trending in a favorable direction and largely self-explanatory. The company remains squirrely about the timing of a separation – with good results, grumbling tends to fade.
Cement pricing remains robust
Gains in volume can get lost in quarterly noise
