Earnings Hindsight: The kitchen sink

I enjoyed the “Earnings Hindsight” setup last quarter and was excited to do it again this time around. But a funny thing happened on the way to the word processor. Or, should we say, something didn’t happen.

Earnings, at least so far, have been pretty boring.

This is a funny thing for me to lament. I’ve gone on and on about how my entire style of investing is built around not having to check in every three months to find out if the sky is falling. I’m not looking for stocks that tend to shed their thesis on a quarterly basis.

But admittedly, that style of investing isn’t ideal if your goal is to maintain a robust publishing schedule. That’s my bad.

You see, try as I may, I am struggling this quarter to find things to get flustered with. The defense primes basically did exactly what they told us they were going to do. They are steadily building their backlogs with new orders coming in response to geopolitical tensions. But those backlogs will take years to turn into actual free cash flow, and in the meantime, they will continue to pay solid dividends based on the business they secured in the past.

Elsewhere much of the same. Yes, the part of the cycle might vary from company to company. But the ships are proceeding through whatever currents they are encountering and remain on course.

So instead of diving in on any company that has reported so far, a few quick observations on what we have seen.

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If there was a standout among the defense primes, it was General Dynamics. We’ve been waiting for this for a long time, but it is finally happening. GD underperformed its peers for a decade because its aerospace arm (Gulfstream) struggled following the Great Recession.

Corporate titans who are shamed for riding on business jets tend not to commit big money to buy new business jets. But those planes don’t stay young forever, and that titan is not flying commercial. So, one of the greatest refreshment cycles in aviation history is about to ramp, and Gulfstream has a fresh and updated product line ready to sell into it.

GD’s defense business is exiting a period of lower-margin grunt work and has strong demand from here on munitions restocking and renewed European interest in land platforms. And the Columbia submarine is perhaps the most important franchise in all of defense. GD has largely closed the valuation gap and I’m personally not rushing out to buy any defense names right now, but the future is bright for those who got in a few years ago.

For years, I gave Textron flack for constantly underperforming somewhere. This is a conglomerate that makes everything from military helicopters to snowmobiles, and for a while it was every quarter, something went wrong. They were the classic “if it can, it will” company. But no more. Textron had its second or third boring quarter in a row. Still not my favorite company, but Bell helicopter is a beast and Textron holders finally have a reason to sleep soundly at night. I’m happy to take back all the mean things I said about it after quarters past.

Don’t sleep on AerCap. This plane lessor is a gem that just keeps rolling. This quarter it was record results and raised guidance. And the scary GE deal that made them an industry titan just continues to not be scary. The company has repurchased $2.65 billion worth of shares so far in 2023, and just authorized another $500 million. So, don’t tell me about the dangers of GE one day wanting to monetize its holdings.

It is easy to forget that in the early days of the pandemic, Chicken Little was willing to sell you these shares for $15 apiece. AerCap is at $61 today. (Book value per share today is closer to $80, fwiw.) It won’t keep appreciating at that rate, and I don’t know if you should buy it today. But I am in awe of how good of a business this is.

XPO is getting good at trucking. Of all the pieces from the XPO schism, the legacy trucking business is the least sexy. And it wasn’t helped by operational hiccups last year.

But all of that is changing. The quarter was magnificent, the operating ratio (a measure of profitability) is falling (low is good), and quality is setting records. A year or 18 months ago XPO’s 2027 margin targets looked like a dream. Now I’m wondering if it will really take them until 2027 to get there.

Finally, Kinsale. Not all stocks go up. Kinsale Capital, the little insurer of the obscure with a fantastic long-term chart, fell 20% after earnings that exceeded expectations and despite rosy talk about the future.

The talk was just not rosy enough.

Here’s what is going on. Insurers make money via (1.) taking more in in premiums than they pay out and (2.) investment income. With interest rates suddenly a thing again, insurers can use that interest income to get aggressive with pricing. Smart insurers like Kinsale won’t fall into that trap, but it will cost them growth.

The selloff (IMO) is overdone, but I get it. And I’m not sure I’d be a buyer into it (disclosure: I probably have enough of it already so I’m a bad one to ask). Kinsale CEO Michael Kehoe has been saying forever that the 40% growth can’t last forever, and yet the market is punishing the company now that it is happening?

That said, the market has given Kinsale a mind-numbing valuation because of that growth. Even after the plunge the company traded at over 9x its book value. Other large insurers it competes with, names like Markel and James River (good companies!), trade at less than 2x book.

(Note, Jason has his own take over at The Smattering. He’s a little worried.)

I’ll concede that given the valuation and the potential for less Earth-shattering growth, the stock could run relatively flat for quite a while as the business catches up with expectations. But catchup it will, eventually. This is still a bit player in a massive market with plenty of opportunity to gain share over time.

Here’s my takeaway: Part of this whole boring investing thing is finding companies you trust. And for me, a big part of that is how little drama there is when things don’t go to script.

To wit, here’s Kinsale’s CEO talking about growth from here.

That’s the kind of panicked reaction I want in my portfolio. And even after the stock crash Kinsale is still beating the S&P 500 by 8x over the past five years.

May all of your 20% movers be so boring.

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