Excess inventory, weakening contract freight rates, Walmart and Target earnings, strong outlook for enterprise software and Palo Alto earnings

We've created a new?Weekly Insights?series where we share our latest thoughts on current themes and hot topics across the Industrial Technology landscape.?This week we focus on?excess inventory,?weakening contract freight rates, Walmart and Target?earnings,?strong outlook for enterprise software?and?Palo Alto Networks earnings.?

CONTENTS

Macro Datapoints??

• Walmart?and?Target's?earnings reports provided another glimpse into the deteriorating economy and health of the consumer. Pressure moving down the supply chain: excess inventory, high freight costs?
• Contract freight rates:?headwinds from spot rates are just starting to translate to freight contracts?

Stocks and Focus Areas

• Enterprise software:?"last in - first out" of a downturn?
• Palo Alto Networks?earnings: strong enterprise spending and Next Gen solutions driving upside?

MACRO DATAPOINTS?

The largest US retailers reported disappointing earnings, a proxy for the US health of the US consumer. Retailers have excess inventory that they are unable to sell and high costs that they are unable to pass through, as consumers budgets are tightening. In addition to excess inventory, freight cost was cited as a major headwind.?

• Walmart?reported earnings that missed estimates and lowered FY22 guidance. The principal driver was increasing costs squeezing margins.?
• Target?reported ~300bp margin squeeze driven principally by excess inventory (~200bp) and increased freight costs (~100bp).

Although retailers expected slow down in demand (e.g. Target), the declines were far greater than their projections. Target pointed to excess inventory in furniture, TVs/electronics, basic apparel and sporting goods. The company expects freight to be an incremental $1BN headwind in F22?(~2/3 related to ocean freight and 1/3 related to fuel increases).?

As retailers can't pass their costs to the consumer, the pressure is getting pushed down the supply chain. Consequently, we are just staring to see signs of?truckload contract rates peaking.?

• Truckload?spot rates?have fallen by nearly one-third since the start of the year, while truckload?contract rates?have risen.
• Shippers buy most of their capacity in the contract market, which means they have?not?seen a reduction in freight rates as of yet, despite the decline in spot rates yet.?
• There is usually about a 6 months lag between spot and contract rates. Declines in spot freight that we have been talking about since March will just start to get reflected in the broader market.
• Truckload contract rates are expected to fall by $0.35/mile.
• The spread between truckload spot and contract rates is nearly as wide as it has ever been, which will start narrowing as contract rates catch up to spot.??For more info see FreightWaves article:?"A Major Cause of Inflation Might Have Peaked". ??

STOCKS AND FOCUS AREAS

Enterprise technology: last in - first out?

A weakening macro and stabilizing inflation may actually be a positive for technology stocks.?Unlike consumer tech, which drove the last technology wave, industrial tech is in the very early innings of adoption with significant growth runway ahead.

Enterprise technology and enterprise software is a?core focus areas for SPEAR Invest. These are companies that are transforming transforming traditional industries across many end-markets (aerospace, manufacturing, auto, construction, biopharma).

• Enterprise software stocks got disproportionately hard hit in May impacted by a broad growth sell-off.?
• Fundamentals for enterprise software and hardware have only improved over the past 6 months, while the stocks have significantly declined (see Palo Alto Networks earnings below).?
• Improving fundamentals and significantly stickier customer base warrant a valuation premium.
• As we come out of this tech downturn, we believe that industrial/enterprise?technology will be the area that offers the best risk reward.?

Focus areas within Enterprise software?

• Cloud vendors and related ecosystems: innovators like?Snowflake,?Cloudflare, are benefiting from strong cloud spending echoed by?AWS (Amazon), Azure (Microsoft), GCP (Google Cloud).?Shift to cloud is not new, but what companies can do with their data in the cloud is evolving every day.?
• Cybersecurity: companies that secure the new architectures and protect end-point devices (i.e. cybersecurity:?Palo Alto Networks, Zscaler, Crowdstrike)
• Industrial Software:?companies that provide simulation and design tools are gaining broader adoption (Autodesk, Ansys, PTC).?

Palo Alto Networks earnings - accelerating fundamentals??

Palo Alto Networks is a comprehensive cybersecurity provider with products across?network security, endpoint security and cloud security. The company reported earnings that exceeded Street expectations on all metrics and?increased its FY22 guidance.?

• FY22 guidance increase from $6.80B - $6.85B (25%-26% y/y)?to $7.106B - $7.136B (30%-31% y/y) driven by NGS ARR up 50%-55% y/y vs. up 46%-50% y/y?
• +40% y/y in 3Q'22 billings ($1.8bn)
• +29% y/y in 3Q'22 revenue($1.39bn)?
• 18.2% operating margins?
• 73% y/y growth in $5M+ deals
• 65% y/y growth in NGS (Next Generation Solutions - Prisma & Cortex)

Interesting to note that while Palo Alto's results were solid, they were not "blow out" (i.e. ~2% topline beat was below recent quarters). The stock price reaction (up~10%) was encouraging as it is confirmatory of our view that we are shifting to?"squeezes on in-line earnings" from "sharp sell-offs on inline earnings" after a pretty brutal start of the earnings season.??

?For more research visit out website?spear-invest.com