It looks like the US-imposed tariffs are moving forward, and we’re starting to hear chatter about retaliation from Europe. Canada and Mexico may be exempt from the tariffs, however.
By Kris Rosemann
Mr. Market reacted unfavorably to President Trump’s top economic advisor Gary Cohn’s resignation announcement March 7, as Cohn was seen as a voice for Wall Street in the White House. Though the reaction may be short-lived, fears of the implications of increasing control from protectionists probably shouldn’t be ignored, and the probability of a trade war, particularly with China (FXI, MCHI) and with Europe, presumably moves higher with Cohn’s exit. Canada (EWC) and Mexico (EWW) may be exempt from the tariffs, however.
The European Union is already reportedly preparing tariffs on certain US brands. A range of consumer goods and agricultural and steel products will be the key targets of a 25% retaliatory tariff on $3.5 billion in US-produced goods should Trump follow through with his stated tariff plans for steel imports. An extension of the retaliation from the EU could take place should Trump’s aluminum tariffs be enacted as well, and the specific measures proposed by the EU have caused a growing level of disagreement among Republican lawmakers.
Many domestic industries are expecting to feel material pressure from the threat of the US-imposed tariffs as well, as a result of the prospect for significantly-rising raw materials costs. One key example is the auto making industry, where some are estimating the proposed tariffs could have a ~$1 billion impact on the annual adjusted operating income of industry bellwethers General Motors (GM) and Ford (F), assuming the proposed 25% tariff results in a similar increase in steel prices. According to some estimates, such a step change would be equivalent to ~12% and ~7% of GM’s and Ford’s 2017 adjusted operating income, respectively.
Though the auto sector has been a key area of focus due to the steel-intensive nature of its production, virtually every company with US-based production using steel or aluminum as a raw material can expect some form of potential margin pressure, in our view. The ability of such companies to use brand strength and other forms of pricing power may be able to mitigate such pressure, effectively pushing the tax further down the line to end-market customers and ultimately consumers. Those with the lowest ability to pull on the pricing lever and the tightest profit margins will experience the greatest impact of the tariffs, in our view. US-based companies with international operations fear retaliation from their international partners, fears that appear to have already been legitimized by the reports surrounding the EU.
In other world news, China continues to search for the appropriate level of foreign investment in its domestic markets as it plans to lower investment barriers for its service sector and pull back ownership limits in certain sectors. The country’s multi-trillion-dollar financial sector has long been viewed as a material opportunity for international investors, but slow market reform and overbearing regulations have stymied such efforts thus far. Global investment uncertainty outside of the country, due in part to aforementioned trade policy uncertainty, has pushed demand higher for foreign direct investments in China, and an increase in such investments will be key for the country in hitting its lofty economic growth expectations.
Meanwhile, progress in the unstable relations on the Korean Peninsula could be coming after North Korea is reportedly willing to talk with the US on denuclearization following the nation’s time spent with its neighbors to the south. Though we had outlined North Korea as a big threat to geopolitical stability in the past, it looks like things are moving in the right direction, but it all could just be posturing on the global stage, too. Regardless of what North Korea says it is going to do–versus what it actually does–it’s likely geopolitical uncertainty will not be going away anytime soon.
BP (BP) CEO Bob Dudley believes crude oil prices (OIL, USO) have settled onto a “fairway” of a range of $50-$65 per barrel for the next couple of years. He credits the recent downturn in energy resource pricing as a learning opportunity for the industry, which is now far more adept at managing costs and gaining efficiencies from new technology and an increased use of data. Dudley also said that he expects peak oil demand to be reached in the late 2030s, though oil demand is still likely to be over 100 million barrels per day in 2040, a level OPEC leaders have suggested the world is rapidly approaching. OPEC has also expressed a concern over levels of investment in global oil production following years of underinvestment during the recent global supply glut that wreaked havoc on oil prices.
Exxon Mobil (XOM) is sure to play a role in satisfying growing levels of global energy demand, and the oil and gas giant recently outlined a set of aggressive growth plans aimed at more-than-doubling earnings and cash flow from operations by 2025, assuming 2017 crude oil price levels hold. The company expects double digit rates of return in all three of its business segments–upstream, downstream, and chemical. Its upstream segment expects to benefit from low-cost growth initiatives in US tight oil, deepwater, and liquefied natural gas. A significant ramp in production in the Permian Basin, a result of multiple acquisitions in 2017, and 25 startup projects worldwide are expected to be key drivers of the upstream growth.
Exxon’s downstream operations expect increased production of higher-value products, including ultra-low sulfur diesel, chemicals feedstocks, and basestocks for lubricants to help expand margins by 20% by 2025. Demand growth in emerging markets will also help in its quest to double earnings and cash flow from operations, and the ongoing integration of its chemical manufacturing segment and upstream production will help its efficiency. The company plans to grow chemical manufacturing capacity in North America and Asia Pacific by 40% to help meet the growing global demand. All in, management anticipates its growth initiatives to result in a company-wide return on capital employed (ROCE) of 15% by 2025, up from 9% in 2017 (including the impact of US tax reform).
Interestingly, the Commodity Futures Trading Commission can now legally classify and regulate cryptocurrencies as commodities after a ruling from a Federal judge March 6 upheld the CFTC’s 2015 decision that digital currencies fit the plain meaning of the word “commodity.” The implications of such a decision are far from clear, and legislation on cryptocurrencies (XBT, GBTC) is still in its infancy as the US federal government has avoided making any significant rulings.
Shares of US-retail giant Target (TGT) faced pressure following its fiscal fourth quarter earnings report, released before the open March 6, despite comparable sales growing 3.6% on a year-over-year basis. Solid increases in both physical and digital channels helped traffic grow 3.2% from the year-ago period, and digital channel sales leapt 29%, good for 1.8% of the total comparable sales growth. However, digital fulfillment costs proved to be a meaningful headwind on margin performance as its fourth quarter EBIT fell to 5.1% from 6.5% in the same period of fiscal 2016. Pricing and promotion initiatives were largely offset by cost savings programs, but SG&A expense came in a full percentage point higher than the year-ago period as a result of higher compensation costs. The company expects both fiscal 2018 adjusted earnings per share and GAAP earnings per share from continuing operations be in a range of $5.15-$5.45 and comparable sales growth to be in the low single digits.
Stay tuned!
Related: SLX, JJU, FOIL
Metals & Mining – Steel: AKS, GGB, MT, NUE, PKX, STLD, X
Metals & Mining – Aluminum: AA, ACH, ATI, CENX, KALU
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.