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I'm your host, Zach Griffiths, head of U.S. Investment Grade and Macro Strategy at Credit Sites, and today we're going to be talking all things consumer with James Goldstein and Jim Dunn, our senior analysts covering the retail and consumer goods spaces, respectively. James and Jim, thanks so much for coming back on the podcast. Thanks for having us.
Happy to be here. All right, James, I want to start with you focusing on the retail side. I know we've gotten through, I think, all of Q1 earnings at this point, and you've had some time to go through them. I know you put out this great weekly earnings note covering all the hot topics and the key takeaways, so maybe just take us through some of the big things that stick out to you from Q1 reporting.
Yeah, definitely. We're almost done. We have one or two left, but the bulk of them are now complete. For me, the big takeaway is, I think, uncertainty is probably the number one word in terms of what we're hearing, both from the demand perspective and also, of course, from the supply and import of goods perspective.
I'd say generally the 1Q results overall were decent, and I think that the concerns mostly focus on what's to come and how consumers adapt to the uncertainty about what's happening, kind of macro perspective, and maybe additionally, what their concerns are about whether we will have tariffs or how large tariffs will be and how that will impact them. So I think we're seeing generally decent demand. There was some weather impact. We had a cold February.
February is always cold, but a full February got the blame for some weak early in the quarter demand, but generally, things seem to pick up a little bit since then. And yeah, the overall demand was okay, but certainly not amazing. It's kind of how I would characterize it. And that varies, of course, between sort of discretionary, non-discretionary elements of retail, which is a trend that we've been seeing for some time now, whereas if you're selling non-discretionary food and beverage, those kinds of things, the demand is still there.
There's certainly value-seeking behavior, but the weaker areas of demand have certainly still continued to be on the discretionary side of things. So apparel, footwear, consumer electronics, those are the areas, I think, where there's the most open questions about kind of how demand will shape up and particularly how that demand will be sustained if consumers do start to face a squeeze on higher prices elsewhere. So how would you characterize Q1 earnings obviously came in right before Liberation Day. There was already some concerns about uncertainty.
And I know I think for about a year now in the discussions that we have regularly, we've been focused on value-seeking behavior and just where, when is the rubber going to meet the road with having to make these more value-driven choices? Consumer sentiment has come off quite a bit, but in general, if you look at the GDP numbers, even looking through all the noise from Q1 that the consumer has held up, I think better than we expected on the strategy team. So how would you characterize that Q1 relative to expectations before Liberation Day hit? Yeah, I'd say, I mean, some of these data points came post-Liberation Day, at least from the perspective of the reporting, but I'd say, yeah, like you said, would have just walked away and said, I'm just too afraid to do anything right now.
And that didn't happen. We didn't have a meltdown, certainly on the consumer demand side. But there's certainly, like I said, pockets of weakness that we can continue to point to and that consumers are just feeling uncomfortable, particularly on sort of big ticket purchases and things like home improvement, big ticket purchases. That's continually being called out as a weak area.
But yeah, overall, not disastrous. It's kind of how I would, not as bad as hopefully thought maybe it could have been, is how I would characterize the overall demand environment for 1Q. I think there was, you know, I think it was Home Depot or I think it was Home Depot said, you know, in the two weeks immediately after Liberation Day, they viewed the recession, that the environment is unambiguously recessionary. They said that lifted off, that lifted fairly quickly.
They started to see some kind of normalization of demand as I guess, you know, I guess by that point, you know, you started to have a little bit of a rollback on some of the tariffs and, you know, this idea that, you know, these are kind of the opening salvos and that there'd be negotiation. I think no one ultimately knows, you know, where these numbers tariff rate wise are going to end up. But I think, yeah, they definitely indicated that, you know, that's the first couple of weeks post Liberation Day were pretty tough on the demand side within the stores, but they seem to, consumers seem to kind of normalize a little bit after that. Okay, great.
So Jim, are you seeing a similar trend of maybe performing better than feared in the first quarter for consumer goods? I know you also covered the cruise lines. I feel like that has largely blocked any trend in terms of slowing or more value-oriented consumer behavior. Is that still the case in your coverage?
Interestingly, I think across the consumer goods space, particularly within consumer staples specifically, results were a bit worse than expected. And those results corresponded with a categorical slowdown in growth rates. James mentioned a retailer, home goods retailer, speaking towards recessionary environment. We had a consumer staples company say that the environment was indeed recessionary in the first quarter.
Of course, there was a lot of broader market volatility that everyone's aware of. Going sort of February into March, as April progressed, a lot of these earnings calls came mid to late April. As April progressed, there were signs of normalization. But category growth slowdown is a key theme.
And this is for everyday purchases, at least categories that are for everyday purchases, including food and beverage categories. And there's an interesting dynamic among food companies where snacking categories saw more of a slowdown than meal prep and meal categories. And snacking companies like Mondelez would say that consumers were focusing on essentials. Just this morning, Campbell's, which is on an off-calendar reporting schedule, said something similar and actually noted that at-home meal occasions were the highest since 2020, early 2020.
We know what's happening in early 2020. I thought that was an interesting comment. So results are a little bit worse than expected. That sort of bifurcation of snacking versus meal prep would signal that the consumer is definitely increasingly budget conscious.
And then measure that against a more discretionary category in cruise. It's a bit of a black and white picture because cruise demand continues to be strong. Only one operator, mind you, Carnival reported in March, Royal Caribbean and Norwegian reported in April. The only company to note any change in booking behavior was Norwegian, which said it saw a period of choppiness in bookings in early April with signs of normalization in the back of the month.
Royal Caribbean saw no indication of changes in bookings and cancellation rates remained normal. That's interesting that the black and white picture between consumer goods and cruise, do you get the sense that that is similar across the leisure space? I know that you only cover the cruise lines now, but in talking to Dave Bussie who covers leisure, is there a difference in trend you're noticing if we kind of look at the past several years in aggregate and what you characterize cruises and why they might be signaling something different than, let's say, hotels? A couple of things jump out that are different between the factors.
One is that the recovery was later to start for cruise. So you could argue that the actual cycle is further along for hotel companies than it is for cruise simply because cruises weren't operating at all for two years. The other bit to note is that there's not a corporate customer for cruises. So to the degree that the uncertainty in the market might have led businesses to take pause, that could have resulted on a room rate basis versus hotels.
So that's an argument that the industry makes all the while. The other bit to consider is that we're approaching peak summer sailing season. Unemployment metrics are still generally good. We didn't expect in-house didn't expect any uptick and cancellations because despite the uncertainty, we still expect consumers to take the vacations that they plan for and have them paying towards absent any broader shock to the market.
So we're in peak cruise sailing now. So that's one reason why we weren't really surprised by the lack of uptick and cancellations because we're seeing change in employment metrics. It's something we'll definitely be monitoring going forward. But I think those factors consider in totality explain some of the differences I think that's a great point on how we're still really dealing with the disruption in terms of the data and the economy from the pandemic.
Just thinking about cruises being offline for two years and now you create an environment where one large portion of leisure or discretionary spending is on a completely different timeline than another that being cruises versus hotels. And I think we've seen a lot of that in the economy since the pandemic and the several rounds of stimulus spending which is making it difficult to use historical norms in terms of assessing where we are in the cycle. I think you're also seeing that in the discrepancy between the hard and soft data. So we can't really have a conversation these days without discussing tariffs in a fair bit of detail.
I think the amount of uncertainty there makes it challenging but how are you guys thinking about tariffs and what have your management teams been saying? Are you noticing any themes in terms of which management teams have been more helpful in laying out their exposure to tariffs as they know them versus less helpful? Jim, what are your thoughts? Let me start with you and how you're thinking about tariffs and what you've learned from your management teams this early season.
Yeah, I guess it varies a little bit by category. More discretionary names tend to import more of their product. Food companies and consumer staple companies tend to have more local supply chains. There are aspects of the goods that are just generally inflationary though because of exposure to imports.
For most of the companies we've seen a clear quantification of the headwind. You know, call it $100 to $200 million incremental costs or whatnot that are coming in and then giving expectations of productivity proven or price pass through or cost savings that they're going to target to offset them. The message by and far has been that their effort will be to offset the cost. Of course, big question markers I'm sure we'll talk about this in a little bit about what level of price pass through they'll be able to achieve.
I don't think we've seen it tested yet. I think we're starting to get to that point because we're starting to hear retailers raising prices and James can speak to that because obviously there's a lag there. More discretionary names like Newell Brands for example under high yield coverage ultimate cost. But I think for the most part management teams have been forthright enough with what their expectation costs are.
The one thing that they can't really quantify we struggle with was demand impacts and if everything's getting more expensive what is the demand impact going to be? I think you expect price elasticity to increase generally. They were, price elasticity were increasing before tariffs so even at the lower reduced tariff rates 10 to 20% depending on the country one would expect price elasticity to increase further and just to reiterate some of the comments I already made category growth slowed prior to liberation day so add that to the equation as well. Yeah, how do you like to look at price elasticity?
Do you have a measure or are you sort of just discussing more qualitatively from what you're hearing from management teams? Yeah, part of it's what we're hearing from management teams I'd say about half of our companies give good data unit level data that looks at organic volume organic price as drivers of organic growth organic sales overall and the simplest way to look at it is if you've got price increasing but volume is decreasing that's your first measure of whether you've got price elasticity going on there in a negative or positive way in this case it would be negative and then if you're increasing price but volume is offsetting that price increase and you're not growing organic sales then that's where you see a sign that you've got not strong pricing power. So Jim, you kind of already did my job for me maybe I'll turn it to James and get his assessment of how much the retailers can pass on pricing to the consumer until demand really falls off a cliff how are you thinking about that? What have you heard from management teams in their expectation of ability to pass on price or are they simply looking to manage it more on the expense management side?
Yeah, certainly an interesting quarter regarding price hikes obviously politicized a bit you had a couple companies come out early in the earning season and say well tariffs are inflationary so therefore we're going to raise prices for our customers which created a whole backlash from President Trump and saying the tariffs are beaten by countries of origin and the retailers and the retailers are making so much money they can just afford to absorb these tariffs which I think anyone who covers this sector closely can say is generally not true there's not a lot of excess margin to kind of stop up the amount of tariffs that we're talking about here and I'm too clear like their names that we cover they're facing unmitigated tariff impacts in the kind of billions of dollars of range so money like Home Depot or Best Buy reported yesterday you just look at the country of origin then you kind of slap the tariff rate from those countries that's currently in place the numbers are huge but at the same time you have most names saying well we're going to find a way to deal with the tariffs you have Best Buy in particular lower their overall guidance for the year by $50 million again in the context of literally $2 to $3 billion of potential direct impact on tariffs I'd say when companies list their mitigation strategies price increases for the retail customer are nearly unanimously last on the list and whether that's a political buffer to avoid being called out as being a price gouger or something like that I think that's potentially true then the first thing that they say is that they're going to try to change the country of sourcing for most of these goods and that's obviously in reaction to China being in particular seemingly the target of Trump's most aggressive tariff measures so now you have all these retailers kind of scrambling to find goods they're sourced somewhere other than China of course almost none of that is moving to America which is the original point of the tariffs but for the most part that's saying okay well we'll try to find someone in Southeast Asia who can produce this for the same good and enjoy for now at least a lower tariff rate we're starting to hear a little bit more of near shoring which generally translates to maybe getting closer to America through Mexico or some basic apparel category Central America is sort of getting a bit of a boost there and historically Central America has had some pretty significant basic apparel production so they're not necessarily doing sort of the higher end or technical apparel but your basic t-shirts and simple apparel they do have some capacity there to do that so I think that's that kind of re-triggering the supply chain to quickly move stuff out of China and into one of these other countries in hopes that wherever these tariffs end up in the end the rates for the non-China countries are below where China ends up and then there's interesting instances and obviously you're hearing this with Apple and other companies where they're currently producing goods in more than one place and some of those goods are currently destined for one country and some of the Chinese produced versions of them are destined for the US and then they say okay well the first and easiest way to fix this problem is to say Mattel or Mattel and Hasbro I think Hasbro these as an example they make Plato in China and they make Plato in India the Plato in India historically has served the European continent and the Chinese Plato has been shipped to the US so their first and easiest fix is okay well now kind of quick and easy fixes right off the bat that they can address then the kind of second level is to say okay well whatever we're still stuck producing in China can we now relocate that to a different country and then say third on the list is going back to the vendors of those goods to the extent of not producing them themselves and saying we're facing tariffs we'd like you to absorb some or as much of this cost as possible that's kind of the third tier of mitigation and then last is generally this idea of going back to the consumer and say okay sorry we tried all the other things now we have to raise prices and I think that's that's kind of how I would prioritize it but for the most part I mean we didn't have any you know massive we had cuts to guidance you know for the year but no one said you know we're doomed with this you know X billion dollars of potential tariff exposure everyone obviously at this stage of the game they have to sort of put on a good face right and say you know we have a way to fix this they can't come out and immediately say this is hopeless but they're putting up a pretty optimistic I see in some cases storyline about how they're going to be able to adjust the incremental costs I think it's also important to keep in mind right so tariffs this is full year guidance that's being adjusted and some cases everyone's saying tariffs on the cost basis are really the second half thing right so it's only half a year's impact and some of these names are some of them are directly importing goods you know themselves and some of them are just sort of buying goods from other vendors so i think part of the best buy story is that they say well we only directly import two to three percent of our goods right so that means 98 percent of our goods are being you know brought into the country by apple or samsung or sony they're paying the tariffs um so therefore we're not directly immediately exposed to tariffs and that's fair that's accurate but our view is well as soon as sony and apple start paying these tariffs they're gonna want to get you know they're not gonna want to see more impression so their next round orders to you they're gonna obviously try to push the prices higher and best buy is like oh we're gonna push the prices lower we're gonna contain those i i think that's going to be an active battle certainly for the remainder of the years too you know who eats tariffs and i think that's certainly one of the great uncertainties yeah that's a really interesting example with play-doh in terms of just being able to take product made in a different country and change what countries it's destined for i imagine that's kind of a rare and relatively inexpensive solution yeah i mean i guess it's happening i guess i don't know i don't but i think that's the apple iphone story right is that moving to indian india sourced iphone is the solution their first layer of solution and that of course doesn't satisfy the trump administration for local production but you know that's the easiest and fastest way for them to protect themselves from the chinese tariffs in particular right i think it's interesting one of your notes you highlighted that excuse me the trump administration has kind of come out and said well we're not necessarily looking to reassure low-tech manufacturing of imperil and other goods like that we're trying to bring back high-tech and military manufacturing which i actually haven't seen before reading your note and so i guess the point is then to move as much out of china into these other places that will end up with lower tariffs as a way to penalize china for its bad acting on the global trade scale for however long in treatment of intellectual property etc so i think that's an interesting point that has really been unclear in terms of what the trump administration is trying to achieve and how likely it will be because there's four or five things that get thrown out there that simply cannot all happen at once yeah i think like when you read that statement and saying you know we're not going after these low-tech we want the high-tech high-margin high-value things like do you read through that and say does that mean he's going to grant an exception to chinese footwear and that kind of you know solves that solve some of that problem of moving whatever's remaining footwares in china over to vietnam or does it mean that what does it mean exactly of course reading between lines is always hard there but i think you know historically there's you know if you look at the trump 1.0 administration right the section 301 tariffs like there have been areas that you know didn't were initially targeted where i think and some of the apparel toys all those things were they're on a list to be you know added to section 301 tariffs and eventually they kind of ran out of steam and said okay we're not going to tariff those things so there's some historical precedent for them saying you know jim and i have talked together together has we're together you know the political aspect of tariffing toys into christmas is certainly an aggressive one so you know there has again been some historical precedent for that category not getting the full tariff treatment but obviously it's you know it's just one of the many great unknowns for how tariffs work out you know the next six to twelve months yeah it's a lot to try to digest and consider all at once so i want to get your guys impression of the divergence in consumer sentiment data relative to the hard economic data which is largely held in so far i think i mentioned that earlier and our analysis shows that personal consumption expenditures are still about 2.4 percent above what the pre-covid trend would imply and so do you think that there's just been a longer lag this time around and the hard data will quote-unquote catch down to the soft data or are there fundamental issues with that data that we can't necessarily say because access happening in consumer sentiment then we can expect why in personal consumption expenditures in the second half of this year jim i want to start with you on that one my my view is that there's a lag i think there's two things there's lag and then consumer confidence often follows headline items more than it does underlying data necessarily so the most recent obviously hilarious example is price bags and years past or cycles past always at the pump gas prices you know those are items that move consumer confidence and sentiment and such and then of course with the volatility in the stock market even if you're not that was so pervasive that and you know obviously had such an immediate impact on 401k balances that had been played in the last couple years that's how it trickles through in ways that i think it shows up even if you're not directly invested you're aware of it but the price increases themselves from pariffs are only now just making their way through i think so this gets me to the lag aspect of it whereby to the degree that there was a snapback in consumer confidence that seemed to correspond with the snapback in the equity market i'm real curious to see what happens when consumers start to see that things are more expensive i think there's a risk that it seemed there's a risk that consumers are lulled into this false sense of everything's good because retaliatory tariffs were paused but that overshadows the fact things are still more expensive even at a lower rate and um as james said even the most exposed companies that we're gonna find ways to you know offset this and the point of price pass through and we spoke about price elasticity already so when i say there's a lag that's the sort of lag that i'm watching and curious about i think some of the names that have spoken a little bit to price you know i think walmart was kind of threatening you know late may maybe start to see some price increases i think best buy yesterday you know despite saying that price hikes were their last resort uh they did do some sort of small round of price increases into that sort of late may period so yeah i think it's but i do generally think it's very early so like i mean the natural question is if tariffs are inflationary why is cpi still so obtained i think that's i think the answer is because they haven't really yet um there's there's more to come down the pike but again ultimately ultimately it's kind of this battle earlier like between the retailer and their suppliers and all these other games they're going to try to play first but it seems like some of that there's it feels like there's still inflationary risk uh that's kind of not priced into uh into what we're seeing at cpi level certainly i would say also it seems like how do you come for that and we've got efficient supply chains right there was pull forward demand categories that were expected to have the largest impact from tariffs and that's potentially why there was a categorical slowdown in consumer staples some management teams did cite an adjustment in retailer inventory levels james and i've talked about this it seems pretty easy to say like all right well we know that we'll be able to get your products and we know where and when how much we'll need and we can keep our inventories we're gonna take space in the back of the store warehouse pull forward products from china take new brands for example which has exposure baby categories much of it produced in china not all but much and their core sales year-over-year growth on a sequential basis move something like 400 500 basis points which is a market improvement and of course management is going to talk about that as just improvement in the category generally but i think that's obvious there's demand pull forward and so that increases your inventory in certain categories and it prolongs when you have to raise prices in those categories so coming i think we're getting closer to that as james said in that sort of may june period i guess it's june already so yeah it'll be in the data eminently apparently and that's been a big part of our view on the strategy side that inflation could be re-accelerating around this time called the second half of this year and that's just not an environment the fed would be able to cut into it might not have to hike but unless the labor market falls apart which we're not seeing yet but if you did have a big drop in consumer demand maybe a little bit more clarity on tariffs companies might be more willing to adjust headcount as a way to offset rising input costs have you guys heard any examples of that from your names yet or are they is it too uncertain to make broad hiring and firing plans right now i think we've definitely heard examples of companies that in addition to the sort of direct mitigation that earlier pushing back pricing on all the supply chain triggering companies have also said well if we have to we'll dig deeper into cost cutting and cost cutting generally means firing people for the most part so we definitely heard names that sort of put that out there as a risk not a ton of names taking action on it so far but i think largely kind of waiting to see to see how things shake out on the actual tarp negotiations how i would characterize it yeah we just had one in the scale of the cost cutting programs that equate to something like one or two basic points of sgna overall so fairly small and they didn't necessarily quantify or qualify whether it was manufacturing jobs or office positions it's still fairly early and the generic response to higher cost was that we would find productivity cost cuts to offset them so as similar to james james's response where those costs are going to come from these are companies that are operating pretty efficiently you know they've been investing in productivity even prior to the pandemic and they got increasingly productive during the pandemic so so potential for higher prices lower employment i wouldn't want to be at the fed to to deal with that combination at the same time but we can save that for another podcast before i let you guys go i want to just get a quick speed round of maybe your top two or three picks in your coverage space and why as a little nugget to leave our listeners with before we go i'll start with you james i think uh names that we that we like obviously there's a lot of noise on the tariff front uh we kind of keep an eye on names that are maybe a little less tariff exposed despite being import dependent uh and also names that potentially have some global diversification so they're not 100 us revenue stream which is obviously a bit of a helping factor uh when it comes to looking at tariff impact you know for these names so on the ig side now we still have tapestry it's a name that uh you know it's a very high margin product and you know the cost of one of the one of the great things about this tariff world is that like a lot of these names have gotten closer to saying like well here's what our actual products cost versus what we're selling them to customers for and we think that you know an average tapestry product is like 20 cents on the dollar for the actual good uh and there's a lot of markup that goes on between there so the tariffs are being assessed at that you know at that 20 cents per dollar import valuation it gives them a lot more flexibility to you know to kind of play around and find ways to save costs that's kind of the same boat crocs on the high yield side uh again very high margin product uh one of the highest margin footwear names that we look at one of the highest margin retail apparel foot name footwear names we look at you know we think that the cost of you know to put it down to dollars a croc pair of crocs clogs cost maybe five or six dollars to import into the us so you can put 10 or 20 tariff on that it's the cost that you can foresee being passed on to consumers without talking about dollar or two incremental costs and obviously every dollar or two hertz but um it's not going to kind of blow up the story and it has had some decent pricing momentum as has tapestry so names that what's kind of demonstrated history of being able to increase prices uh and kind of below average uh margin of patch because they're starting from a high margin perspective uh are the kind of names that uh that we like uh we're still uh we're waiting here on dollar general dollar general reports tomorrow which probably is not tomorrow but time here at this podcast but they're you know kind of value-seeking world i think that's an interesting one uh they struggled a little bit last year year and a half or so that's kind of adapted the change and changes in the ways that consumers are shopping but we do think that that kind of value play uh downshifting out of you know eventually potential downshifting out of sort of mid to higher market sources of groceries because all general most of their businesses consumables are their grocery or consumer products and health and wellness products and that's uh we think that there's some potential gain for them there as well so those are the kind of ones i would highlight at the moment within my names um beginning with consumer products generally i think a name that we look at for higher quality in the low single a high triple b ratings product ratings category would be church and dwight it's a company that has a little bit of higher exposure to value brands so if you see increased exposure and value-seeking mindsets they could stand to benefit but also just given the slower category growth we haven't seen any meaningful moves in the credit profile so this name it gives you extra spread relative to higher quality names like kimberly clarker procter gamble colgate palmolove so we're comfortable going down in ratings and getting that extra spread this is a consumer staple still use category company so despite what i mentioned about slowing categories generally pretty resilient company i'm in food and beverage space looking at triple b's we like names like campbells and sjm smucker both are deleveraging from recent debt funded mna and when you might you might ask well if they see slower category growth what happens their deleveraging ambitions we don't see things getting to the point where it upends their deleveraging and we thus like the deleveraging as an additional positive attribute to the credit story and um when you look at spreads uh being a bit wide to mid to high triple b comps like general mills or mondelez which are also facing category pressures uh not pressure per se but slower growth we just like that added focus being on improving the balance sheet and uh it's a dynamic that we'll watch of course given the slowdown that we've seen uh in snacking categories in particular but campbells and sjm smucker are two names there and then we talked about cruise uh it's more of a crossover story over there royal krippin just crossover to investment grade we like the story generally but we have a market perform view we're positive on carnival cruise which we expect to have ig-ish metrics in about a year's time awesome well james and jim thanks so much for coming back on the podcast i enjoyed the discussion and learned a lot i'm sure we'll have much more to discuss in the second half of this year as we see how tariffs play out and maybe we'll get you back on to update how things have gone relative to expectations so that's james goldstein and jim dunn from our consumer retail team thanks guys thank you and thank you all for tuning in we will catch you next time on no more risk better credit sites offering or soliciting any transaction with respect to the purchase or sale and security received by this listener of this podcast is not the gimmick of a credit sites for its affiliates