Oct 15, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • WeWork executives prefer taking on a roughly $5 billion financing package led by JPMorgan to stay afloat rather than selling a controlling stake in the company to SoftBank. (Bloomberg)
  • JPMorgan reported record revenue and profits that topped expectations, kicking off earnings season for the big banks. (CNBC)
1 big thing: Streamers wrestle with debt
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Data: Moody's; Chart: Axios Visuals

Streaming companies are accruing more debt to sustain heavy investments in content, Axios' Sara Fischer writes. In addition, their leverage (debt to EBITDA ratio), is higher than it has been historically.

Why it matters: While most analysts agree that the debt loads at most of these companies are manageable for now, some firms are beginning to feel investor pressure to manage rising debt before it gets out of hand.

Driving the news: Under pressure from activist investor Elliott Management, AT&T said last week it will sell its wireless and wired assets in Puerto Rico and the U.S. Virgin Islands for about $2 billion to Liberty Latin America.

  • AT&T said in the announcement that it would sell $6 billion to $8 billion worth of assets this year, but this deal puts the total at $11 billion.

AT&T is in a precarious position, argues Jonathan Chaplin, an analyst and managing partner of New Street Research.

  • "AT&T has the lowest leverage of the four (Comcast, AT&T, Disney and Netflix), but they also don’t grow EBITDA."

For Comcast and Disney, the trajectory is much more optimistic. "Some companies can justify debt because they have defensible niches and stable cash flow," says Michael Pachter, a research analyst at Wedbush Securities.

Netflix, on the other hand, has seen its free cash flow dwindle this year. And as a result, its leverage is the highest compared to many of its streaming rivals and high compared to the industry average. (See chart above.)

  • The company, which will spend roughly $15 billion on content this year, is the only company of its major streaming rivals that isn't profitable. It relies on the debt markets to fund its growth.
  • "Ultimately, they are going to have to generate free cash flow to pay back their $12.6 billion of debt, and it looks to me like they will be close to $20 billion in debt before they get there," says Pachter.

What's next: Netflix is under increasing pressure to grow its user base if it ever hopes to offset is massive debt.

  • Investors are looking for international subscriber growth when it reports earnings Wednesday to offset any threats from rival streaming services that are set to launch later this year and next.
  • Its stock has taken a beating after the company reported weak Q3 user additions.

Bottom line: What Netflix has going for it is its businesses is "genuinely raising debt to face the shift in distribution models," argues Chaplin. That's a big reason investors remain bullish on the stock, despite the fact that it's burning tons of cash.

Go deeper: How Netflix burns $10 million a day

2. Trump's sanction threats sink the Turkish lira again

The lira fell to a nearly 5-month low Monday, again pushing toward the psychologically important level of 6 per dollar, as President Trump pushed forward with sanctions against Turkey, increased previously imposed steel tariffs and threatened further penalties.

  • The lira has been the world's weakest major currency so far this month, Reuters reported, having fallen 5% in just 2 weeks. That dip comes at the same time a gauge of broader emerging market currencies has risen more than 1% against the greenback.
  • However, it bounced Tuesday as Trump's imposed sanctions were seen as less harmful than expected.

What's happening: In addition to Trump's threat that “big sanctions on Turkey are coming," EU governments also agreed on Monday to limit arms exports to Turkey, though they stopped short of a formal embargo.

  • “I’m struggling to see a positive trigger event (on Turkey) at the moment,” Allianz emerging markets CIO Richard House told Reuters. “It is just quite staggering what is going on.”

Deja Vu: In August 2018 the lira fell by as much as 20% in 1 day after Trump threatened to double recently implemented tariffs on metals imports, pushing the currency to its lowest level ever.

  • Turkish President Recep Tayyip Erdoğan exacerbated the currency crisis by pushing for sustained low-interest rates in an attempt to stimulate growth and then effectively firing the central bank governor for not cutting rates quickly enough.
3. Health care stocks aren't having a great year
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Data: FactSet; Chart: Axios Visuals

The stock prices of major health care companies have not kept pace with the broader market so far in 2019, even though the industry is flush with cash, Axios' Bob Herman writes.

The bottom line: Medicare for All and other health care reforms floated by Democratic presidential candidates, as well as higher-than-expected medical costs at health insurance companies, have made investors nervous about the future.

What's next: Companies are ready to roll out third-quarter reports.

  • Politics will continue to hang over how investment firms trade health care stocks, but Wall Street has a short attention span.

Watch this space: Stock buybacks in Q3 rose 27% from their level in Q3 2018, analysts at Bank of America Merrill Lynch said in a recent note to clients. Health care companies have been the biggest driver with "near-record weekly buybacks" last week, they said.

Follow along: The Axios health care earnings tracker has been updated with Q3 details and also includes large not-for-profit hospital systems.

4. Why America isn't at full employment
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Data: FactSet; Chart: Axios Visuals

The Fed has two jobs: Keeping inflation at 2%, and ensuring full employment, Axios' Felix Salmon writes. But what does full employment mean? According to Minneapolis Fed president Neel Kashkari, we're clearly not there yet — despite the fact that the unemployment rate is at a 50-year low of 3.5%.

Why it matters: If we're not at full employment, and inflation remains below the 2% target rate (as it does), then the Fed has little choice but to step on the gas.

Until we see wage growth net of productivity climbing at above 2%, then we're not really at maximum employment. Kashkari, in an interview with Axios

By the numbers: Hourly wages were $27.91 in June, up 3.2% from a year previously. (They've since decelerated a bit, with September's data showing earnings growth of 2.9%.) Productivity, meanwhile, was growing at a 1.8% pace in June. Which means that wage growth after accounting for productivity is well below the Fed's 2% inflation target.

  • The U.S. won't be at full employment, says Kashkari, until that number rises to above 2%.

What they're saying: Kashkari tells Axios that the headline unemployment rate is "almost useless" in determining whether the U.S. economy is at full employment.

  • The unemployment rate only counts people who are actively seeking work, but most of the new jobs being created are going to people who weren't actively seeking work during the previous month — people who didn't count as unemployed.
  • So the unemployment rate doesn't give a good indication of how many more people the economy can gainfully employ.
  • Instead, Kashkari likes to look at wage growth. "We're trying to assess supply and demand in the market," he says. "The best way of assessing supply and demand in the market is to look at the price. The price of labor is wage growth. And until we see wage growth net of productivity climbing at above 2%, we're not really at maximum employment yet."

The big picture: Kashkari is a noted dove, and it's not clear that other Fed officials would agree entirely with his analysis. But it's undeniable that wage growth is low. If Americans started earning more money, the Fed would likely welcome that as a sign of economic health, rather than worrying that it might start causing too much inflation.

Dion Rabouin