Bonds, Solar, and Cheese Balls

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So the story doesn't have to be a hard landing next year, but I think certainly it'll be one of further deceleration. And the consumer itself, I think, kind of moved through that savings they built up from the COVID fiscal stimulus.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Adam Abbas. He's a co-head of fixed income at Oakmark, which means, among other things, that he manages bond portfolios. In a moment, he'll talk about the relative attractiveness of bonds and other income investments, plus some other stuff. He does not have a rosy view of stocks. What he does have is a prediction on mortgage rates. That's coming up. First, I'll say a few words about solar power and cheese puffs. Listening in is our audio producer, Jackson. Hi, Jackson.

Cheese puffs? Really?

Questions are pouring in. People are— I'm here. I'm hearing from all corners of the globe. People are saying enough about artificial intelligence and the Magnificent Seven and what's going to happen with inflation.

So no one's been asking about cheese puffs.

Well, not yet, but you can sort of sense it in the subtext of what they are asking about. So we'll get to it. Let's start with solar. Jackson, are you a solar panel owner? Do you have any? Are you in the game with solar power?

Well, I'm, I'm a renter, so there's none on my house. But we do have pretty old windows that get good southern-facing sunlight.

Passive solar, I believe they call it.

Yeah.

And it heats up about 10 degrees.

Don't forget your camping charger. You told me you got a camping charger too.

Yeah, yeah.

I have a phone charger that you can take when you're camping. The problem is it only gets you about 1% an hour.

All right, well, look, you're part of the solar revolution then. I'm a 52-year-old man, and on the street where I grew up as a young kid, there was a guy who had solar panels on his roof. I mean, solar power has been around for a long while. You had to be something of a hobbyist to do it then. Today, you call one of these big companies and they show up and they provide everything, including the financing. And you can buy your solar stuff outright, you can borrow for it, or you can lease it. I had a couple of companies out here to my house to make quotes on solar panels maybe a year or two ago, and it was a close call. I mean, the issue was they couldn't provide enough solar power to run the whole house. They would say, well, if you took down this line of trees, but I like trees more than I like solar panels. That was a nonstarter. So I decided in the end to take the money that I would have spent on solar and I replaced my two fireplaces. I had these inefficient open fireplaces. I replaced them with modern closed-door fireplaces that can heat the whole house in the winter and the geothermal doesn't even come on. But I remember when I got these proposals from the solar companies, they said, well, you can, you can buy it outright, you can lease it. They had all the different things. And of course, that's dictated by interest rates. The higher interest rates go, the worse of a deal solar becomes. And it was already a pretty close call for me. So you can imagine what has happened lately with interest rates shooting higher to people who are trying to decide whether to get home solar. And that, I think, has been reflected in the share prices. I'm looking at Invesco Solar ETF. That's a bundle of solar stocks and the ticker is TAN, T-A-N. And the summer before last, the share price of that was over $80. It was over $85 at one point. And by this past Halloween, it was 41. That's a collapse in these stocks. But Halloween is ancient history. Since then, we had a Federal Reserve meeting where policymakers signaled that they will cut interest rates next year. Inflation has cooled by a lot from its peak, and the Fed seems to be of the opinion that its rate hikes have had their intended effect. It's going to wait and see a little while longer. The current Fed funds target is a range of 5.25% to 5.5%, and policymakers at the Fed now project that interest rates by the end of next year will fall to 4.6%. The previous projection was a half point higher. All sorts of interest rate-sensitive stocks jumped on that news, including solar stocks. So that solar ETF that I said had hit $41 a share by Halloween, that's bounced back to about $50, still well off its high. Some Wall Street analysts point out that investors should distinguish between home solar and utility-scale solar. In other words, those big solar fields that utility companies use to generate power centrally and then distribute it to their customers. Last week in Barron's Magazine, I mentioned a small company called Fluence Energy. The ticker there is FLNC. Fluence makes batteries for utility-scale storage. That's important for solar power in particular because the sun shines during the day. It's nice to have somewhere to store that extra power that you don't use so you can use it when the sun's not shining. Okay, so Bank of America Securities points out that whatever's going on with home solar, demand for utility solar and storage is still fierce. They just came away from a yearly conference they have, their energy storage conference, and they called it, quote, the single most upbeat in our history. They point out that the price of lithium-ion phosphate that's used to make batteries, that has fallen by nearly 3/4 this year. And they predict, quote, a step function increase in storage deployments. And a step function increase is a way to say a lot more while sounding fancy, I guess. BofA says that growth is going to be particularly strong in two markets. California, and that has to do with some policy reasons there, and Texas, and that's purely economic reasons there. And so Bank of America recommends shares of Fluence Energy. That's a $4 billion company. It's on, let's say, the cusp of profitability, and sales beyond this year are seen doubling over 3 years to about $6 billion. I saw a similar case recently from the investment bank Jefferies on a company called First Solar. That is a large US-based manufacturer of solar modules. And Jefferies points out that for one thing, the company has a very strong backlog, and for another, it has mostly exposure to utility-scale solar, which according to Jefferies has a better growth trajectory than residential solar. Jefferies says the market for utility-scale solar is expected to grow 24% next year and then 18% per year on average through the end of the decade. First Solar is sold out through 2026. Jefferies predicts 25% average compounded revenue growth through that, and it has pretty strong bookings beyond then through the end of the decade. And overwhelmingly, most of its contracts are ones that either customers can't back out of or ones where they have to pay a steep fee to get out of the contract. And that's money that has already been put down as a deposit. First Solar is spending a lot of money now to grow, so it's expected to burn cash both this year and next. But if you look ahead, let's say 4 years into the future, the Wall Street consensus that the analysts who have ventured guesses out that far say that the company can generate free cash of about $3 billion per year. And this is a $17.5 billion company. So if it gets to that point, that's a lot of cash. That's if it can meet all those growth targets. I guess the point here is that if you've been interested in solar stocks before but found them to be prohibitively expensive, they have sold off with rising rates because of the way that's going to weigh on home solar. But there are some stocks out there that have more exposure to utility solar, which is still growing nicely. And those are Wall Street's positive cases on a couple of them, Fluence and First Solar. Ready for cheese balls, Jackson?

Oh yeah.

I might have oversold this. It's, um, I'm saying cheese balls, but it might be more of a potato chip and a tortilla story. I saw recently that Mizuho Securities, that's an investment bank, initiated coverage of a company called Utz Brands, UTZ. I hope I'm pronouncing that right. They give it a buy rating. They say it's headed to $19 a share. Who knows? It's recently $15 and change. And some other analysts have either initiated positive coverage or turned positive on the stock lately. And I saw that the company had an Investor Day this past week. So let's take a quick look. Jackson, are you familiar with the Utz brand? Have you seen it in stores? When I say Utz, what do you think about? Or maybe you don't know it. Do you know it?

Not really. I'm thinking pretzels. I have pretzels in my head.

Oh yeah, they do all kinds of pretzels. You can get a barrel of Utz pretzel rods. They do the Bachmann brand, right? They do Zapp's Sinfully Seasoned pretzel sticks, H.K. Anderson peanut butter filled pretzels.

That's impressive.

These are not names that maybe roll right off the tongue. I mean, one of them might be your favorite, but if I say Utz potato chips, that doesn't, that doesn't ring bells in quite the same way as Lay's or Doritos, right? Doritos. Utz has its own brands of tortilla chips. One of them is called On the Border. Never seen it. Another word, another one is called Tortillas, but it's spelled with a Y-A-H-S exclamation point on the end. Tortillas. Never seen that one either. A few things that I've read in these analyst reports. If you're wondering whether we've talked about the rise of these new obesity medications that make people, they sort of curb people's urges for snacking and all that stuff. And if you thought that that was going to cut into sales of snack food, it doesn't really seem to be happening. The research says demand for food is still growing fine. Snacks are growing faster than food overall, and salty snacks are the fastest growing part of snacks.

Are there any salty snack analysts we can get on?

I know some snack analysts, but I wouldn't describe them as salty. Utz has exposure to 4 out of the 5 leading categories in salty snacks, which are— Jackson, tell me the 5.

Potato chips.

That's one.

Tortilla chips.

That's two. So far you're nailing it. Go ahead.

Pretzels.

Meat snacks is number three. Your jerkies, your— I guess your Slim Jims. Number four is popcorn, and number five is cheese snacks. This is one of those cases where the things to like about the company and the stock are the things that are wrong with the company. In other words, the, the areas for improvement. The good thing about Utz is that it seems to participate in the right categories and that it's growing nicely. It's outgrowing other snack food companies. The main things to not like about it are it's too small, it doesn't have enough distribution, it has too much debt, and it's not a particularly efficient operator. But those are fixable problems. Utz has been on something of an acquisition binge. It's done 14 deals since 2011. Those deals bring in not just new snacks but also new distribution routes. Even so, it has only about 11% of the distribution of the king of all snacks, Pepsi, which has the Frito-Lay business. Household penetration isn't great. Here's some numbers that come from Jefferies. For the Utz brand of potato chips, household penetration is at 20%. For Lay's, it's 80%. For Ruffles, it's 54%. And for Pringles, it's 52%. Utz is a little bit below Kettle.

What does that mean? Just the households who've heard of it or who have access to it?

The number of households that the chips have penetrated, meaning not just penetrating the structure. They made their way in the front door. They've also made their way into the people in those homes.

I'm going to think twice before buying some Cheetos. I don't think our home has been penetrated yet.

Okay, so I'm looking at a map of where you find Utz mainly, and it's mostly the Northeast, the Mid-Atlantic states, and the Gulf states. There's a huge part of the country that the company has yet to expand to. I'm looking at California, Jackson, where you are. You are shockingly under Utz out there. So I'm not surprised that, you know, the name doesn't— that the images don't spring to mind of all those snacks. Also, all those deals that the company did, it's left it with this hodgepodge of manufacturing and distribution facilities that are not operating at full capacity. It has plenty of room to consolidate, which would improve margins. The company has plenty of debt from that deal making. They can pay that down gradually from its free cash flow, or there's some other low-hanging fruit here. If you want to grow sales for a company like this, you advertise. Oats' advertising spending is one of the lowest of any of its peers as a percentage of its sales. If you're Mondelēz, the maker of Oreos, you're spending over 5% of sales on advertising. Hershey, about 5%. General Mills, 4%. If you're Oats', you're spending 0.7%. But Oats' revenue growth rate over the past several years has been one of the best across the snacking category. So the idea is if you wait for more of that growth to roll in, that will to pay for more good things like increased advertising and lower debt. That's the bull case anyhow. The company, at its presentation to investors this past week, predicted a return to its historical growth rates. Before the pandemic, it was growing volumes at about 2% a year and prices at 2.7% a year. During the pandemic, you had huge inflation, so prices increased by 9%. That skewed the growth rate, but now it predicts from now through the end of 2026, 1% to 2% volume growth per year and 3% price growth for total revenue growth of 4% to 5% a year. That's pretty good for the food business. Okay, so that is Solar and Cheez Balls. And these are not, these are not stock picks. I mean, they're someone's stock picks, but for me, these are just pieces of analyst research that caught my eye and I'm sharing the information with you. You can make your own decisions. Don't go around and tell all your friends that Jack Howe from the "Barron's Streetwise" podcast says, sell everything and put it all in First Solar and Utz. That's definitely not what I'm saying. Although if they both go up a lot, I knew it all along. That's how they do it in the asset management business. Let's take a quick break. A good time for a snack, by the way. You know, 90% of the U.S. population snacks at least once per day. That's from that Utz presentation. Also, average number of snacks per day per person, Jackson?

Uh, I'm gonna have to get a 3.

It's 3.3. You're turning out to be a Snacking Genius, by the way. You're getting everything right. We'll have a quick break and we'll come back, uh, and hear from Adam Abbas about bonds.

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Welcome back. Let's get to my recent conversation with Adam Abbas. He's co-head of fixed income at Oakmark. Bond yields had shot up to the highest levels that investors had seen in a long time, but in recent weeks, prices have risen, yields have fallen, and I asked Adam, have investors who haven't bought yet missed the boat? How do bonds look now?

That generally the forward returns, uh, after real rates go above 1.5% at the end of hike cycles are quite attractive for especially higher quality fixed income assets. And we still think, yeah, you know, there was a large move with spread and rates over the last couple months. You're talking 100 basis points plus, but that there's still a compelling argument to be in fixed income if you're willing to kind of work through the next 3 to 5 years.

When Adam uses the word real, as in real rates, he means after inflation. I spoke with Adam before the release of the Fed's December meeting minutes. That's where officials predicted 3/4-point cut by the end of 2024. So since then, the 10-year Treasury yield has fallen to around 3.85%. But what Adam says still holds. 10-year forward inflation expectations are around 2.2%, and that puts the real yield on that 10-year Treasury, the nominal yield minus the inflation expectation, at 1.6%. There's another reason Adam says bonds still look attractive. It's the comparison with stocks.

I certainly think there's a compelling reason on a relative basis as well.

Relative to stocks?

Relative to, yeah, risk assets, stocks, kind of the lowest parts of high yield. I think the ultimate slowing of the economy that comes from the cumulative effects of this rate hike cycle are yet to put their full weight on the economy. And I think a lagged effect shouldn't be confused with no effect. I think the last couple months have been— you've seen stocks and bond correlations quite high, and that implies that the market's saying, look, we got a couple decent inflation prints finally below expectations, and therefore, you know, we're out of the woods. There's this immaculate deflation scenario or the soft landing scenario that we've kind of jumped to now. And I think we would just caution that You know, this— the full force of the restrictive policy, I think, has yet to be felt in the broader economy.

And what could go wrong from here? Are we talking about a recession that people are now maybe not expecting? Are we talking about inflation maybe not staying under control? What do you think will happen?

Yeah, I don't think you want to overcomplicate it. I think we— let's say we still have rates above 4.5% for most of next year. You know, money supply is going to reverse fairly sharply from where we were in the COVID era and You know, there's not major supply constraints out there. I think fiscal spending will stay run fairly hot next year, but be managed a bit more carefully. And the cost of capital is higher. And that means the private market capital has to be choosy on how it's deployed and the ability to pass through prices. I think companies are getting pushback now in many industries. So the story doesn't have to be a hard landing next year, but I think certainly it'll be one of further deceleration. And the consumer itself, I think in the middle, lower cohorts are kind of moved through that savings they built up from the COVID fiscal stimulus. It's important to note as well, I think the effect will be that there is more elasticity in the average consumer, i.e., more sensitivity to pricing next year. And, and that just all points to, you know, further slowing. I don't necessarily think it has to be a hard landing, a crash, let's say.

What parts of the income world should I favor right now? And I know that part of that has to do with who I am and what type of risk I'm willing to take on. So let's just say that I am average in every conceivable way. And so, you know, that, that being the case, where are the relative values right now across income assets?

Well, I think the people should take a hard look at what we call the core plus space. This is a core aggregate holding of high-quality investment-grade bonds and government bonds topped off with some high-yield exposure. And in that exposure today, you can get around 6%-ish, 6.5%, depending on the holding of pre-tax all-in yield. And we think that's pretty compelling.

Adam says that now is a good time for active management in bonds, and that's something that I often hear from active managers, and Adam is one such active manager, so it stands to reason. But for bonds, even more so than stocks, indexing strikes me as awkward. If you want to make an index of stocks, you can just weight companies by their stock market value. That's what the S&P 500 does. Proponents of fundamental indexing will say, why should you weight companies by their stock market value? That just means you have more of them as the prices go up, as they become more expensive. You should want to have less of things as they become more expensive and more things as they become cheap. Better to weight companies by measures of economic value like sales and cash flow and dividends. Okay, fine. But with bond indexes, weighting sometimes goes according to the amount of outstanding bonds, which means that the entities that owe the most have the heaviest weightings. And that seems stranger still. Adam talked about which parts of the bond market he likes most. He finds good value in lower quality bonds, riskier bonds, junk bonds, you might say, but not at the index level, not if you're buying a big basket of them. He says below the surface, there's been a lot of dispersion And that's turning up some good deals in single issues.

I think a great example was a Raising Cane's new issue that came to the high yield space about a month ago. One of the best operators in the restaurant space, nice critical mass of stores with 700-ish-plus stores in the US, great brand recognition, consistent profitability, top-tier margins. And we got to own this at 9% plus. It was a first-time issuer to the high yield market, so it wasn't without risk. There's one sole shareholder who is the founder and in control. There's no board. And there's some free cash flow burn to fund their expansion. But we're primarily focused on building fundamentally great businesses in our portfolio. And if that means we'll sacrifice $300 million of cash burn per year, but they're growing a business at around 15% and a profitability more than that, we think it can be a good investment and will ultimately build business value over time.

Hold on, I'm Googling. It says Cravable Chicken Finger Meals. So I see a 3-finger combo here. Do I have the right company?

You do indeed. So really, they've built something unique in that they've— they're kind of in the upper scale chicken tender class, let's call it. So they're really trying to approach that. They have a more high quality product in the chicken tender space. You're going to get clean stores, you're going to get a better tasting product, and you're going to get great service. And you're going to be able to charge $20 for that chicken tender basket instead of $15.

I like an upscale chicken finger. I might have to check them out. I just want, I just want to call out that they have an offering here. They have what are called tailgates. There's a 75-finger tailgate that they say feeds 19 to 25 people. I might have to, might have to take down one of those for the, for the family and friends one day. I wanted to ask Adam about mortgage rates. He's not a real estate guy, but mortgages eventually become bonds. And Adam's a bond guy, so he ought to know a thing or two about where mortgage rates are headed. It's been a very difficult situation for prospective homebuyers. Not only are house prices not particularly cheap, but financing rates have shot way up, which means potential monthly payments are much higher than they used to be. So I asked Adam what's next.

You can't expect mortgage rates to come down, maybe 1 or 2 points. I think sometime in, again, late '24 or in '25, But I don't think you can expect— let's say if you're anchored to what we had before in the zero interest rate policy era, I think you're going to also be disappointed. So I think we have begun a new higher interest rate regime and that means rates we really believe will come down, but maybe stick in that 3 to high 4s range. And that probably means your mortgage is going to be sticky in 5, 6, 7% range. And so I think if, if we're waiting for to get that 4 handle or 3 handle mortgage again, I think you're going to be disappointed as well.

So, so don't, don't hold out for too long thinking you're going to bottom tick the market at 2.58% on a 30-year fixed. That's not happening.

That's 100%. And if, if you, if you're lucky enough to have that 30-year mortgage at 3% or 2.5%, you can pat yourself on the back. It's, it's a nice, you know, it's called a liability, but really it's an asset.

Yeah, but don't tell your friends you're locked in at that rate. Everyone's tired of hearing it.

Yeah, right. Yeah, we know.

Keep it to yourself.

We know.

Thank you, Adam, and thank all of you for listening. Jackson Cantrell is our producer. Jackson, tell folks something personal about yourself. If you were an Utz snack, which one would you be?

I think the sizzling hot crunchy curls.

Okay. I had you as more of an extra-thin pretzel, 1-ounce vending machine package, just hanging on by a corner after someone's already put their money in.

I'd never do that to someone.

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Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.