Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good morning. Markets took a tumble yesterday. Tesla’s 12 per cent dive was not a total surprise given its weak earnings report. What was a surprise was Alphabet falling nearly 3 per cent despite solid earnings, and other tech names following. Something is going on. Thoughts on what it is? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.
French fries, inflation and asset prices
Lamb Weston is an $8bn global company that slices and freezes potatoes. It sells them mostly to fast-food restaurants such as McDonald’s, which fry them. The day before yesterday, it was an $11bn company that slices and freezes potatoes. The difference between those two numbers is Wednesday’s awful earnings report, which featured a 5 per cent decline in revenues, a collapse in earnings and a dreary outlook. Here is the everything-but-the-kitchen sink explanation of the problems the CEO provided on a call with analysts:
Our sales and earnings performance fell well short of our targets due to a combination of targeted investments in price, a decision to voluntarily withdraw our product to ensure we meet our quality standards . . . higher-than-anticipated market share losses, an unfavourable [product] mix, and softer-than-expected restaurant traffic trends in both the US and many of our key international markets
The story of both the poor results and the plummeting share price is, at its core, simpler than that. Start with the performance of fast-food restaurants, which has indeed been slipping. What’s gone wrong? Not a big drop in overall consumer spending or even spending at restaurants generally. Jake Bartlett, a restaurant analyst at Truist (and an old friend) says that recent weakness at fast-food chains — confirmed by Truist debit and credit card data — comes down to price increases backfiring:
Fast food took too much price leading to a narrower value advantage . . . consumers are either trading up to fast casual (i.e. Chipotle) or down to grocery (much smaller price increases there)
This is a pandemic story. Covid led to a series of shocks in the restaurant industry. No demand during lockdown, then lots of demand with the release of excess consumer savings and a tangling of supply chains that led to a supply shock. All of this was inflationary, and restaurants — like many other businesses — increased prices to protect their margins. And more than protect them. Here is McDonald’s operating margin pre-pandemic though the first quarter of this year:
Lots of people called this “greedflation”. But it is a company’s job to be greedy. What is supposed to restrain price increases is not generosity, but competition. And as the pandemic recedes into history, competition is returning.
Which leads us back to Lamb Weston. They had a very nice pandemic. Here is their quarterly sales:
You can see why investors would get interested in any company whose sales growth looked like that. Indeed, between early 2022 and mid-2023, Lamb Weston’s shares doubled. But where the value of a stock is concerned, it matters where increased sales come from. In the case of Lamb Weston, almost all the increase in sales came from increased prices. Here is what the CEO said about that yesterday:
We’re targeting specific investments in price and trade support to protect share and win new business . . . our sales growth [in the future] will be largely volume-driven unlike the price-driven top line that we’ve delivered in recent years . . . we expect our earnings performance will be driven by a combination of volume growth, improved mix and cost savings. In recent years, our earnings growth has been largely driven by price.
Meaning: competition is forcing us to cut prices, and future revenue and profit growth will be — for the first time in years — driven by selling more potatoes. This is the news that cost the company more than a quarter of its value.
What the Lamb Weston saga shows is that the disruptions of the pandemic years are still very much present in asset prices. Inflation, which took many forms, continues to resolve itself in fits and starts. The pig is still not all the way through the python.
Like a lot of stock market conniptions, Lamb Weston’s looks logical and predictable in retrospect. Processing potatoes is a commodity industry. Every processor is a price taker. Of course the pricing power associated with the pandemic and its aftermath were not going to last. Of course pricing the stock for sustained growth — it was trading at 30 times trailing earnings at one point last year — did not make sense. But it is not easy to analyse economic disruptions in real time as they unfold around you.
One good read
FT Unhedged podcast
Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.
