The Q3 Call of a Company You Don't Own
A fictional earnings call, Thursday, October 1. Ashgrove Industrial does not exist. The yields, the indexes and the Micron print around it do.
Operator: Good morning, and welcome to the Ashgrove Industrial third-quarter call. All lines are in listen-only mode. I'll hand it to the CEO.
CEO: Thanks. Orders up 9%, backlog at a record, operating margin 14%, pricing held through the quarter. By any operating measure this is the best three months in our history. I'll turn it over to our CFO to explain why the stock is down 11% since mid-August.
CFO: Thanks, and I'll be brief, because the explanation fits on a Treasury screen. Our revolver and term loan float off SOFR. With the funds rate at 3.75% to 4% after September's hike, our all-in cost sits near 6.7%. When the 10-year was under 4% in March, a new line at our Ohio plant cleared the hurdle with room to spare. The 10-year touched 5.29% this week, the highest since 2007, and the 30-year printed 5.62% on Tuesday, the highest since 2002. The same line item now needs a return it has never delivered. Nothing about the plant changed. The ruler did.
Analyst 1: Congratulations on the quarter. I have to ask, though. The Dow lost 4.3% in September while the S&P 500 lost half a percent. Why is your tape behaving like the Dow's?
CFO: Because the Dow is a basket of companies that make things and borrow to do it, and the S&P is a basket in which a few names carry the weight. The Russell 2000 closed Wednesday's regular session near 2,808, almost 10% under its mid-August peak above 3,069. That is the official definition of a correction, and it arrived with no recession, no credit event and no bad news. Our whole sector is being punished for good news.
Analyst 2: Explain that. The data this week was strong. Second-quarter GDP was revised up to 2.2%. ADP printed 90,000. You just told us orders are up 9%.
CFO: Right, and each of those prints lengthens the Fed's runway. The Atlanta Fed's GDPNow had third-quarter growth near 5% last I looked. A 5% economy with inflation at 3.4% on the headline PCE is a Fed that keeps its hand on the lever. Core PCE came in at 0.2% for August against 0.3% expected, October hike odds fell to roughly 35% from over half, and the 10-year went up anyway. I am a manufacturer. I watched good news raise my cost of capital in real time.
Analyst 1: To be fair to the market, Micron put up $54.2 billion of revenue, guided to $61.5 billion, and the stock went nowhere.
CFO: Micron is worth about $1.2 trillion and just told you it will spend roughly $25 billion on capex across the first half of next year. A company that large can fund a cleanroom out of cash flow and out of the market's patience. I fund mine with a bank. So Micron flatlines on a record quarter while I fall on one, and the difference is only that they get disappointed at a higher altitude. Nasdaq got a late lift from mega-cap tech on Wednesday while the Dow and the S&P gave back. The index you own is a bet on who can afford the discount rate.
Analyst 2: Is there a version of this where rates help you?
CFO: Oil falls, flows through the Gulf return, the war ends. The Journal says shipments are back near 80% of pre-war levels, and WTI is around $90, which sounds relieving until you remember it is still up some 42% on the quarter. The Secretary of State sent Iran's delegation home this week. I don't write guidance around diplomacy. I write guidance around what my banker tells me on the first of the month.
Analyst 1: What are you hearing from customers?
CFO: They are shortening their order horizons. A year ago they asked for twelve-month pricing and I said yes. Now they ask for ninety days and I say maybe, because I can't price my own debt past December. Five Fed officials are speaking today, including Barkin, Collins and Schmid, and my sales team is refreshing a news feed instead of calling accounts.
Analyst 2: Any read-through from this morning's data?
CFO: ISM Manufacturing lands at ten Eastern, and the consensus is 55 against 54.6 last month. I will tell you what I told my board. A reading above 55 helps my order book and hurts my multiple. A reading below helps my multiple for roughly as long as it takes someone to say the word stagflation. Friday's payrolls carry a consensus somewhere around 85,000 to 90,000 with unemployment at 4.1%. I have a scenario for each outcome, and every one of them involves the rate staying put.
Analyst 1: Last one. Capital allocation. Are you still buying back stock?
CFO: At a 6.7% cost of debt, buying back shares is a leveraged bet that my own multiple recovers before my covenant does. Our board has paused it. We will pay down the term loan instead, which returns exactly what the Treasury market has told us the risk-free rate is, plus a little. I realize that is the least exciting sentence you will hear all earnings season.
Analyst 2: So guidance?
CFO: We are not guiding to a number this quarter. We are guiding to a rate. If the 10-year stays above 5%, we sit on cash and wait. If it falls back toward 4.5%, we build the line in Ohio and the stock will probably catch up without any help from us.
Operator: That concludes today's call. Thank you for joining.
CFO (to a colleague, microphone still live): Did the ten o'clock number come out yet?