Should We Care About the Weather?

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

February 2nd, 2014

Should We Care About the Weather?

ARG, in its earnings release this week lowered its guidance for the first calendar quarter of the year, in part (but only in part) due to the exceptionally cold and snow and ice filed weather that much of the country has seen in January. ARG is a very good coincident indicator of US activity in manufacturing, home healthcare and a number of other key economically-sensitive end markets.

  • We see two issues which could materially impact companies in Q1 2014, one of which was covered in detail by Rob Campagnino in a research piece this week, where he estimated that with a 9% colder than average winter – what we have seen so far – households will spend more than $21 billion heating their homes this season. That is $21 billion that will likely be cut from other discretionary spending (or added to the household debt burden).
  • The second issue is business interruption itself and this points more towards the ARG comments. It looks as if large parts of the South East have spent a couple of days this week at a standstill, and the extreme cold in the North East has inevitable slowed construction and other business. School snow days also cut into productivity.

We would be concerned about companies that have high expectation for earnings growth in Q1 2014, that have very low degrees of “skepticism” (i.e. are trading in anticipation of near-term improvements in returns and earnings), and with high exposure to the US.

  1. We have already highlighted GNRC as a risk in our 14 for 14 piece and while the cold weather might give a slight boost to demand, this remains an expensive stock in our view with very high return on expectations.
  2. WOR is also at risk in our view because of exposure to general US manufacturing coupled with high valuation/expectations.
  3. Packaging – PKG could see some demand declines as the consumer has less to spend and also if volumes shipped in the quarter slowdown – this is another stock with both high valuation and high expectations. We would also highlight SEE here, but while the stock is discounting significant improvements from already high values and has a bit of a cult following today (which is always dangerous), it does have much of its business outside the US and consequently unaffected by the US weather. LPX, MWV and IP all continue to look expensive and could see shortfalls. Note that in our monthly – published today – we talk about the lack of revenue growth in paper and packaging. High operating leverage is implied in very high earnings estimates and operating leverage works on the way down as well as on the way up.
  4. Trucking/Transport – both ODFL and JBHT look risky to us. High values, high expectations and real risk of lost business and higher maintenance costs in Q1are the concerns. The car rental companies could also see a poor quarter but they do not screen as particularly expensive on our framework with the exception of R, though the longer term nature of lease and rental agreements for trucks should make R less vulnerable to revenue shortfalls than HTZ and DTG.
  5. On the home improvement/building front, RPM is the most exposed in terms of expected growth and valuation, though POL and SHW should be a concern.

Overview

The chart in Exhibit 1 repeats a chart shown in work published by Rob Campagnino last week and illustrates how much colder this winter has been relative to last year and a longer-term average. Natural gas prices are as much as 20% higher this winter versus last winter – impacting the price of gas itself and large amounts of electricity. Heating oil is a little cheaper than it was a year ago but heating oil is a very small part of the US total when it comes to heating fuels – natural gas and electricity dwarf everything else.

Exhibit 1

The table below – Exhibit 2 – shows the more highly valued companies in our coverage universe together with expected Q1 2014 earnings growth, the percentage of sales that is in the US, our measure of skepticism (optimism or high expectation where the number is negative) and the average annual EPS revision (a 12 year average where the history is available).

There are a lot more companies in the table than we have listed in the summary above – but we have not focused on those with less than 50% of business in the US. However, any company with earnings growth expectations well above normal for Q1 2014 is vulnerable in our view.

Exhibt 2

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