Barron's Streetwise - Walmart’s Return to Growth. Big Tobacco’s Somewhat Smokeless Future.

Episode Date: March 31, 2023

Jack and Jackson discuss why stocks aren’t tanking, and size up a pair of recent Wall Street upgrades. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Are we doing a cold open? The coldest. Cold open. There you are. Oh, I thought that was a gold finger. That's it. Is that what you're going for? Okay.

It was. Don't tell me we owe someone money for rights. I barely got into the song. We're open for business. This is the Barron Streetwise podcast. I'm Jack Howe. I'm here with our audio producer, Jackson Cantrell. And we're going to just talk about a couple of topics today that I wrote about this past week. And we're going to answer a listener question. We're going to talk first about why the stock market is not crashing. I mean, it usually doesn't crash, but we're coming right after a banking crisis. Why aren't people more worried than they are?

Why is the market up? And second, we're going to talk about a pair of analyst upgrades this past week on Walmart and Philip Morris International. Not because I'm so wowed by the investment case for these two stocks. I mean, they both have their appeal, sort of. But just because I think that people are generally interested in those businesses, first of all. And also, sizing them up now gives a sense of where we stand in the broad market, what the opportunities are like. And the opportunities are, eh, I mean,

they're not great. We'll get into that. And then we're going to answer a listener question. It's about, Jackson, international stocks? International stocks, exactly. Wait, can we check one thing real quick? So on your QuickTime audio recording that should be going, if you click the... I've got a setting on my recording here. It says under quality, it says high or maximum. Am I supposed to be on maximum? Because I'm only on high. If the quality of this podcast is low...

I think high is good enough for us. We'll go to maximum next week and do a poll. I'm going to say things of medium quality at a high quality setting. So we've talked about by the dip itis before. Is this by the dip itis? I guess it might be by the dip itis. We had a couple of bank failures. We had some bank bailouts and you would expect people to be nervous. And then you look in the S&P 500 was recently up. Where are we up? 7%, Jackson? Yeah, 6.74. Did you just take me to two decimal places? All right. On the S&P 500, we're going to call it

7% for the year. But this is coming after a couple of bank failures and some bank bailouts. And you think people would be nervous now. So, you know, on one hand, you say, OK, the stock market fell 20 percent last year. So maybe people are buying while they can while it's cheap. But it's not particularly cheap. It trades at over 18 times this year's earnings estimate. times this year's earnings estimate. And what you usually get after a bank scare like we've had is you get a credit freeze or a credit tightening. Banks become fearful about lending too much. They become fearful about credit quality. And the pullback on loans means capital is less available, and that's bad for growth, and that can send an economy into recession, and that can be bad for company earnings. So why aren't investors more worried about that now?

Some people say they should be, right? Mike Wilson over at Morgan Stanley, he's talked to us here on the podcast recently, and he says price-to-earnings ratios for the market could fall precipitously and unexpectedly. And he says that the recent underperformance of small caps and low quality stocks means that that's imminent. So there's that. There was a note from Goldman Sachs. And Goldman expects that the house view of Goldman is that stocks are going to kind of end the year around where they are now. And there's not going to be much earnings growth, but we're not going to see a big plunge in earnings estimates either. Goldman's top economist put a note out early this past week, and he called the recent bank crisis a headwind, not a hurricane going forward.

And he has four reasons that he says that this is not going to become a big drag on the economy. And the first one he points out is that lending already looks lean, right? Banks have been tightening up on credit since the middle of last year. So some of this is baked in. And second, large banks in particular, they have higher liquidity standards than small ones. They're unlikely to reduce lending further. The third is that this bank crisis, we've talked about this, it was set off in part by losses on treasury bonds. Remember, Silicon Valley Bank had bought those long-term treasuries and rates moved against it and it expected to hold those bonds to maturity, but it had to sell some to raise money

and it sold them at a loss and that spooked depositors. But the thing is, what investors have been buying when they've been worried are those same treasury bonds, those same types of bonds. And that has pushed prices for bonds higher. So that has helped to reduce part of the problem. Banks that are out there sitting on paper losses on longer term treasury bonds, those losses have been getting smaller because investors have been buying those bonds. That's the opposite of what happened during the global financial crisis 15 years ago. Assets that were at the center of that crisis continued to

lose value. And the fourth factor that Goldman's economist points out is that commercial real estate, that's a big source of loan demand for small banks. And that was already struggling. So again, maybe the downturn there is already baked in. So he doesn't think that this will be a big, huge drain on the economy. And maybe that explains why the stock market is holding up. I want to point out one other view, and that's from Savita Subramanian over at B of A Securities. She points out that the S&P 500 is priced for yearly returns over the next decade of 7%. Now, we talk often about how you can't predict what the market's going to do in the near term. Over the next year, who knows? You can make some educated guesses about what the next 10 years or so are going to look like

based on starting valuations. Starting valuations are a key predictor. And 7% returns are below the historical average for the market. So what Savita is saying, in other words, is stocks look a little bit expensive right here. And we're going to see returns that are lower than what we're used to. So she calls the 5% or so yields that you can get in short-term treasuries and money markets, a compelling alternative in the near term. And I think that's how a lot of investors feel.

You mentioned the 5% return on cash. Where are you getting that right now? Well, it's close to 5%. I'm looking at some treasury yields right now. 4.9% on a six-month is kind of the best on the yield curve right now. And that falls off pretty quickly as you go further out. So if you go out to 10 year bonds, you're only getting three and a half percent. That's a weird shape for the yield curve. We've talked about that before, but Savita says, you know, be careful about going out for those longer bonds. Basically, there are two reasons why you might be worried about the stock market, or at least two things I'm thinking about. One is,

is this banking crisis over? We don't really have the sense that we're worried about these overnight deposit runs, but we're still in a situation where small banks are kind of ceding deposit money that they need to larger banks and to money markets. So where does that take us? Is it just a gradual moving of cash to smaller banks that need those deposits? And so does this continue to be a problem throughout the year? And the second thing is the debt ceiling. No one's talking about that, right?

That's like out of people's minds, but it's not that far away. No one's talking about that, right? That's like out of people's minds, but it's not that far away. We could have a debt ceiling issue by mid-June at the earliest and maybe the end of August at the latest. And we'll find out more about the timing when we learn after April what tax receipts look like. And so I won't go into details about what the debt ceiling is or means. We've done an episode on that, but it's basically this showdown that you can get in Congress and it can rattle bond

markets and how much it rattles bond market and stock markets depends on how far lawmakers are willing to take it. And you get a sense from the sort of divide that you see in Congress right now that they might be willing to take it pretty darn far. I don't know. So that maybe becomes an issue later in the year. We're in this in-between period. We're in this calm period that might last weeks or months. And who knows, maybe the debt ceiling issue will be solved nicely and smoothly. I don't know. But I think that's a reason why people might be worried, might want to have a little extra

safe money in the near term. I hate the idea of market timing. I'm not good at it. But if you're tempted to have some extra safe money in the near term, those reasons might be why. So if you're looking for safe money, you can get close to 5% going out six months. If you go out 10 years, you have to take less. And Savita just points out, you know, you could do that, but just keep in mind, the

stock market becomes safer the longer you're willing to commit your money to it. In other words, there's a high degree of uncertainty about how well you're going to do in the market over the next year. You can be reasonably more confident, not certain, but reasonably more confident that you'll make money if you hold on for 10 years. And if you can hold for longer than that, you become more confident the longer you hold it. So it's just to say that the longer you're putting money away for, the less fearful you

have to be about what happens in the near term. So the S&P 500 index, Savita sees a 7% return. But if I'm a savvy stock picker, maybe I could find some deals out there. So what are you seeing out there, Jack? Are you a savvy stock picker? I've had mixed success. Yeah. Mostly failures. Okay. Well, that's brave of you to admit it. I don't feel like the savviest stock picker, but I look around to see, you know, what caught my attention this past week were a pair of upgrades from analysts on two blue chip stocks, right?

Walmart is one, Philip Morris is another. I'll start with Walmart. That has an investor day coming this coming Wednesday. And the company, they've been investing a lot of money and they're doing a lot of, they probably wouldn't want me to call them Amazon-y type things, but they are Amazon-y. They've got the Walmart Plus business. That's a subscription business with an estimated 10 million paying members there now. Between Walmart Plus and Sam's Club, Walmart might be generating about $5 billion in membership dues, which is a nice

starting point, right? And there's a high margin advertising business, kind of like Amazon has. This one's called Walmart Connect. There's a data service for suppliers called Luminate. There's a delivery platform called Go Local. There's warehouseate. There's a delivery platform called GoLocal. There's warehouse robots. There's experiments with the drones carrying packages and so on. So you've got all that Amazon-y type stuff. What I think investors will want to hear from Walmart, what they're used to, they want to know that revenues are going to grow long-term by at least 4% a year. And they want to hear that operating profit can grow a bit faster than that. And you don't really know what you're going to hear from management. Sometimes there was a day last summer when management said, hey, inflation is causing people to spend more on their groceries. So

they're pulling back a general merchandise. So we have some merchandise that will have to be marked down. And investors sent the stock 7% lower in a day. So you don't really know for sure. An analyst at Evercore ISI, Greg Mellich, he's optimistic. He upgraded the shares this past week to outperform from inline. And he just says that investments that management has been making in omni-channel, that's making the stores and the online business play well together, that investments are paying off, and he thinks that there's going to be margin and traffic upside for the next couple of years. Earnings per share have been declining.

They're probably going to decline again this year and then rebound next year. That's the street expectation. Greg expects the same thing. He's a little bit above consensus estimates. He writes that amidst a decelerating retail world, we like Walmart's scale, balance sheet, and stability. Are you hitting your buy button? Well, the stock is 24 times this year's earnings forecast. So, I mean, you got to have a lot of stability.

Explain that more. 24 times earnings. What does that mean? Well, I just said that the stock market trades over 18 times earnings. And I said that that was high compared with a long-term average. A long-term average is something like 15 times. And so we've just, over time, gotten used to these higher valuations. But if you're paying 24 times earnings for something, you would expect it to be growing very quickly. If you got something growing slowly like Walmart to get comfortable with paying 24 times for the stability alone, I'm just saying it sounds pretty ambitiously priced. It could certainly work. Right. because if it didn't grow at all, a 25 times expected earnings is just a 4% return. Yes, except the dividends are presumably paid out from the earnings.

So yeah, you're exactly right. The stock at 25 times, that's like a 4% earnings yield. And you compare that with what you're getting in the bond market. You say, if you're not getting growth, you say, why bother? But, you know, Greg says his price target, 160 bucks, gives you about 10% upside for shares. I think it's, you know, that's a reasonable expectation for a business like that. And it's a 1.6% dividend yield. Okay. So, you know, that's kind of a stable business that he sees as an attractive price, but to me, it gives you a sense of the deals that skilled stock pickers are seeing out there.

It's not like they're giving away the store right now on valuation. Yeah. What about Philip Morris? That was a JP Morgan upgrade. Jared Ges at JP Morgan upgraded his overweight from neutral this past week. And his price target works out to about a 20% gain from where the stock was recently. And the dividend yield there is over 5%. That stock is cheaper relative to earnings. It's about 15 times earnings. It's a cigarette stock, obviously. So you think, well, isn't smoking declining all around the world? I wouldn't say it's collapsing. What's happening is that population growth worldwide is offsetting the decline in smoking rates. But the push at Philip Morris is also, the company's motto is delivering a smoke-free future, which is maybe an overstatement and maybe not.

You be the judge. Is that true? I'm going to lay out a scenario. Bank of America delivering a money-free future. Yeah, that's kind of it. I'm going to lay out a scenario where it might be true. Here's how it could happen. So Philip Morris has vape products, right?

And it has this proprietary Ico system. That's like you have, I don't know if you call them cigarettes, but you have rolled tobacco and you put them in this device and it heats it, but it doesn't burn it. So it delivers the nicotine without the smoke. And there's a new model for that device. It's called Aluma, and it's selling well overseas. There have been some production delays, but it seems like demand is decent there. So then the company bought Swedish Match.

And that makes these tobacco pouches that you put between your lips and your gums. So that's another smokeless product. And all of that could get the company to 40% smokeless revenues by this year. And the next thing is it bought from Altria. Altria's right to US sales for Icos. And so the next step is to really grow Icos in the US. And JP Morgan calls the US the largest nicotine profit pool in the world. And so that's enough that it could get the business to half smokeless revenue by let's say 2026.

If you get there, you could envision the company at some point splitting the business in two, right? And if you split the business in two, you got your smokeless future. And then you got your smoke-filled future. Yeah, yeah. Right. But the part you keep is the smokeless, right?

You say, hey, we spun off the smoky part. We're keeping the smokeless future. So I guess, right? So JP Morgan's prediction for growth there is about 8% to 11% a year over the next few years. The analyst calls it a unique best-in-class growth story. I don't doubt that it's best-in-class. I mean, if you look at the rest of the class, Altria invested $13 billion in a vape business called Juul, and that was banned by the FDA. And there were concerns about youth vaping.

Some of the early flavors for that were like mango and creme brulee. Um, but the band didn't have to do with youth smoking. It had to do with technicalities about the marketing application. Anyhow, uh, the, the upshot is that Altria wrote down 95% of that investment. So an enormous loss on an enormous amount of money. And then the other main player in the group is British American Tobacco. That makes Newports. It's a big leader in menthol cigarettes. And when there are groups, anti-smoking groups that are looking to ban cigarettes, they often are pushing especially hard to ban menthol cigarettes. Is that fair to say? Yeah, I'd say so. They see menthol cigarettes as a type of cigarette where it might get new smokers into smoking.

Yeah. And so they want to ban them. So that's an overhang for the stock. That's a risk there. So that's Philip Morris. Again, about 15 times earnings. It's twice as expensive as Altria or British American relative to earnings. So those others are discounted for some of their problems. I do think Philip Morris stacks up well against the broad stock market in terms of its earnings

growth potential in the near term. And certainly, its dividend income. I don't think it's quite the staple that tobacco stocks used to be just because this is a fairly radical product overhaul going from many years of selling cigarettes. And we know exactly how those work in and out of economic cycles to now selling new types of things and devices that we don't know quite as much about. Fair to say? Yeah, I'd say it's fair. Have you ever smoked cigarettes? No, not a one. No, I had one as part of a halloween costume but i didn't smoke it

you just had it dangling out of your mouth yeah it was i was uh winona's right winona writer's character from stranger things though the mom so i had i had like a bunch of uh i had a wig and a bunch of lights um like the christmas lights and a phone. All right. And were you under 18 at the time you were doing that? Uh, no, I think I was 19, but now I think the age is 21 in the U S. But you were okay. You weren't, so you weren't in violation of any laws. No, no. Okay.

But I actually don't know. Can you be a kid and have a cigarette? Like if you're in fourth grade and you have a cigarette in your mouth, but it's not lit. Right. Is that illegal? Handcuffs. For you and your parents. You know,

we talked about two stocks. Like, so, so what's the full, what's the full picture here? You know, what have we learned? I'm struggling to get excited about the stock market. I'm

certainly not selling out of it because I'm terrible at timing the market and telling what the market's going to do in the near term. I've talked about this before. I allow myself these ranges. It's kind of like bowling with bumpers. I allow myself these ranges on my asset mix where I say, I've got to be no less than this percentage in stocks and no more than that percentage. And I don't trade often. But, you know, we're kind of at that point in the stock market where I'm saying to myself, should I like raise a little bit more cash than I usually have? And the yields on cash are quite good. And like I say, the outlook for the stock market is, eh, right?

What do you think? Yeah. What do you think? I think that's fair. Yeah, I mean, I'm just looking at my high-yield savings account. All right. I see the interest payment coming in every month, and I'm pleasantly surprised. Don't brag, Scrooge McDuck.

What are you working with there? What kind of a yield are you working with these days? 4%. Nice. not not bad you can shop around you might be able to get four and a half four and a half a man of your stature you should be commanding four and a half you want to do a quick break and then return with a listener question let's do it. First to know what's going on and what that means for you and for Canada. This situation has changed very quickly. Helping make sense of the world when it matters most. Stay in the know. Download the free CBC News app or visit cbcnews.ca.

TD Direct Investing offers live support. So whether you're a newbie or a seasoned pro, you can make your investing steps count. And if you're like me and think a TFSA stands for Total Fund Savings Adventure, maybe reach out to TD Direct Investing. Welcome back, everyone. Jackson, we have a question from a listener. Yeah, we have Josh Radman. Surely it's pronounced Radman, right? But you're saying Radman, like he's rolling in on a skateboard or something like that. Okay.

Sorry about that, Josh. Let's hear your question. Hey, Jack and Jackson, love listening to your podcast and thanks for a great laugh each week. I'm curious to get your perspective on international equities. I've been surprised by how many advisors seem to recommend keeping a good chunk, say upwards of 20-30% of your portfolio in international stocks. But it seems to me like many American multinationals already give you that exposure. Plus, with international equities, you just have added currency risk, political risk, interest rate risk, not to mention generally more opaque business practices and accounting standards. I recall Warren Buffett has always said, never bet against America. And I'm curious to get your thoughts. Thanks. Great question, Josh. Do you need money in international stocks? How much? It depends on where your home country is. I think if your home country is the United States and you have

some home country bias, that's okay. It's a big market. It's a developed economy. And as you rightly point out, the largest companies in the US have major operations all around the world. So if you own an S&P 500 fund, you already have some international exposure. Warren Buffett himself once wrote in a letter to shareholders about the advice he gave to his trustee for money to be left to his wife. He said, my advice couldn't be more simple. Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 fund. Warren Buffett has also written, as you say, not to bet against America. I don't

think he regards buying international stocks as quite the same as betting against America. Berkshire Hathaway has owned some of the past. It's had a stake in Taiwan Semi, for example. I'm not sure that you need a lot of international stock exposure for diversification. I think you might want some, actually, for return potential. And I know that sounds absurd to say at this moment, because we've come to such a long period that the US stock market has been beating up on stock markets of other developed markets around the world. It's been many years. But that also leaves us in a situation where overseas markets look cheap relative to the U.S.

Also, overseas currencies look cheap relative to the U.S. And when you have that combination of conditions, a cheap currency can help overseas markets to sell more. It can help corporate earnings growth there. It can eventually help with stock returns. I don't know if we're going to have some big rebound in overseas valuations or some reversion to the mean in overseas stock markets, but I think that if you're someone who's hunting for stock market values, it might be wise to keep

some exposure overseas. But I don't think it's a must, and if someone out there tells you a hard rule about you have to have 20%, you have to have 30%, I don't feel that way. Jackson, I think that's a good place to leave it. Say something that'll just bring a sense of finality that'll really wrap this thing up, give people warm feelings. Just put a bow on this thing. Go ahead. Go for a walk, everyone.

Go for a nature walk. You'll feel better. Good. Cigarette hanging out of the mouth or no? Not going to light it. Just hanging out. No, the smokeless future.

It could also go above your ear. Okay. That's cooler. Yeah. Thank you for listening. Jackson Cantrell is our producer. You can subscribe to the podcast and Apple and Spotify. You can write a review on Apple and we'll see you next week.