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  • Writer's pictureEric Cinnamond

The Worm Turns

<June 7, 2023>



In May 1991 I returned home from college to search for a summer job. My go-to gig at Baskin Robbins was no longer available since the store had new owners that weren’t hiring. Knowing I was looking for a job, a good friend told me his dad was looking for help at his brake repair shop. I contacted his dad and began working the next day.


The mechanic’s day starts early with the bay doors opening at 7:30 a.m. I walked in and was introduced to the crew: Sonny, John, KC, and Tom. If they had guitars and a drum set, I’d swear I just met the band Mötley Crüe (one of the members pictured above). The lead mechanic, Tom, showed me around and taught me the basics of preparing a car for inspection. I began helping put cars on the lift and removing tires. The shop was hot, loud, and very busy.


Over the noise of air impact wrenches and 80’s rock music, Sonny ordered me to retrieve a wrench. That should be easy, I thought. As instructed, I found a wrench and quickly brought it to Sonny. Instead of saying thank you, he yelled, “That’s a 3/8 you dumbass, I asked for a 10 mm!” Oh no, what did I get myself into?!


As the weeks went by, I slowly earned the respect of the mechanics. They often tasked me with doing some of the dirty work that made their lives easier. The work was so dirty that they began calling me “Worm” as my uniform was usually covered in dirt, dust, and grease. I was a mess. That said, I survived the summer, made some cash, and even learned how to repair brakes. It was a great experience, and I’ll forever be grateful for the “Crüe.”


One of the things I was surprised to learn while working at the Brake Center was the percentage of customers that consider auto repairs to be discretionary. There were several instances when we took off the tires, inspected the brakes, and discovered major repairs were needed. After being presented with the cost, some customers asked us to put the tires back on and would leave. I’d watch the car drive off the lot, taking note of the model to make sure I avoided them on the road!


I was reminded of the Brake Center and the discretionary nature of auto repairs after reading Monro Inc’s most recent conference call. Monro, an automotive repair chain, shed light on a developing trend we’ve been documenting over the past two months. Specifically, consumer companies are increasingly reporting disappointing earnings and providing numerous examples of growing consumer stress.


In Monro’s case, management noted its customers were trading down to lower-priced options, saying, “As our customers continue to look for more choice and greater value, sales of our opening price point tires were a larger proportion of our overall tire sales.” In response, management raised prices on their lower priced tires. Problem solved for profit margins, but certainly not the consumer.


America’s Car-Mart provided further commentary on the automotive and consumer environment, explaining, “We've gone from a period of consumers having trillions in stimulus with zero inflation to no stimulus with very high inflation. In our industry…inflation has been especially pronounced, showing up in used car prices, parts, shop labor rates, transport services, all being at record highs. Interest rates for auto loans have escalated sharply…credit availability was tighter year-over-year by 8.5% across all loan and lender types in April. Consumers have been stretched and affordability has been tight.”


The more discretionary the item, the more pronounced the slowdown in consumer spending. While my kids would disagree, I can’t think of anything more discretionary than a $200 pair of sneakers! Foot Locker recently rattled investors by announcing a 9.1% decline in same-store sales and slashing earnings guidance from $3.35 to $3.65/share to $2 to $2.25/share. The company seemed surprised by how quickly demand declined, with April and May dropping off sharply. Management commented, “Sales trends have slowed significantly, just in the past one and a half months…the softer-than-expected trends that materialized beginning in April have continued into May.”



Foot Locker’s results provided additional evidence that inflation is restricting discretionary spending. Management explained, “When you think about just from a household spending perspective, inflation, while abating, is still high, higher than before. So the basics in people's household, whether it's gas, food or rents are elevated in terms of cost. So that puts pressure on the ability to spend discretionary dollars. People are just having to be more choiceful, as they think about discretionary spend. And, we also see an increase in usage of credit.”


Foot Locker isn’t alone in feeling the negative consequences from persistent inflation and the consumer's lost purchasing power. And to reiterate what we’ve been documenting for several months; the inflation rate appears less important to the consumer than the inflation that has accumulated to date. In our opinion, the rate of inflation could drop to 0% tomorrow and the stress associated with past inflation would remain. In effect, it’s the significant amount of purchasing power that has been lost over the past two years that is driving consumer decision-making, not the monthly fluctuations in the rate of inflation that amount to fractions of a percent.


Dollar Tree discussed the effects of accumulated inflation and the stress it’s placing on consumers, saying, “The consumer continues to be under pressure. There are simply fewer dollars available to them, and those dollars are not going as far as they did a year or two ago. We are past the multiple rounds of government stimulus. SNAP dollars have been reduced and tax refunds are running lower. These impacts, combined with persistent inflation, have more families prioritizing needs over wants.”


Ross Stores had similar comments, noting, “As a result of today's uncertain external landscape, especially the prolonged inflationary pressures negatively impacting our customers' discretionary spend, shoppers are seeking even stronger values...”


Shoe Carnival also pointed to the persistence of inflation, saying, “The biggest headwinds that our customer faced in Q1 were persistent inflation across everyday expenses they need to spend on, interest rates continuing to climb and unexpectedly, federal tax refunds ended the quarter with a nearly 10% reduction versus the prior year.”


The Children’s Place made similar comments, saying, “Given the significant macro-economic headwinds, including the continuation of record inflation and tempered consumer sentiment…the Company has now taken a more cautious consumer outlook.”


Big Lots noted its lower-income customers have been hit particularly hard, saying, “Specifically, our lower-income consumer has been hurt by inflation and by lower tax refunds and higher interest rates. And their confidence has been shaken by banking failures.”


Big Lots reported a whopping 18% decline in same-store sales and an adjusted diluted per share loss of $3.40! With its stock trading near $5, Big Lots’ market capitalization has crashed to $150 million from $2 billion in 2021. The company repurchased over $600 million in stock between 2021 and 2022 with capital that it surely would like to have back today. And of course, Big Lots isn’t alone. As profit booms turn to bust for a growing number of companies, we expect “buyback regret” will reach record highs this cycle given the significant amount of capital allocated to share repurchases.



And while Walmart isn’t a small cap stock, we believe its comments on accumulated inflation summed up what many of the consumer businesses we follow are experiencing, saying, “The persistently high rates of inflation in these categories lasting for such a long period of time are weighing on some of the families we serve…” According to management, accumulated inflation in categories such as dry grocery exceeded 20% over the past two years, putting the consumer “under a lot of stress.”


Based on recent reports from many of the consumer companies we follow, we agree with Walmart—the consumer is under a lot of stress. Even with unemployment near record lows, the average consumer is having trouble affording tires, shoes, apparel, and other goods. The main culprit, accumulated inflation, is crushing middle to lower-income consumers. Meanwhile, high-end demand is allowing many companies to raise prices as they cater to those benefiting from asset inflation (Make Less Make More). It’s quite a dilemma for the Federal Reserve. As asset inflation spills into consumer prices, accumulated inflation continues to build, reducing the standard of living for most Americans and making it difficult for the Fed to cut rates as the market anticipates.


With accumulated inflation showing no signs of reversing, consumers are fatigued and running out of options to sustain their standard of living. We believe the slowdown many consumer companies experienced in April and May is a new and important development. Have we finally reached a point of spending exhaustion where the decline in the middle- and lower-income consumer outweighs the growth in spending from the higher-end? From our bottom-up perspective, it appears a growing number of consumers have reached a tipping point. While two months don’t make a long-term trend, we believe the worm has finally turned. The all-important consumer is slowing.


Eric Cinnamond



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