I may have said this before, but it’s worth repeating. Yogi Berra famously said: “You can observe a lot just by watching.” Truer words were never spoken.

One of my favorite places to “observe” and “watch” is an individual company’s earnings call transcript. Inside these sometimes lengthy documents I often find nuggets about the state of the business and the economy which shape my investment decisions. It’s especially useful to review the earnings transcript of a company which has just blown out earnings expectations and offered bullish guidance.

Take for example, the recent earnings report for MRO (maintenance, replacement, and operation)/supply chain management giant W.W. Grainger (NYSE: GWW), where the company beat expectations handily and offered sound guidance for the foreseeable future. As the price chart shows, the stock moved nicely higher, with the post earnings response capping a massive move in the shares that began in late 2023.

Grainger’s business, is to procure, store, and ship industrial products, ranging from industrial tools to HVAC systems, building materials, testing equipment and even cleaning products. In addition, they offer technical support and inventory management services. Their customer base includes businesses, corporations, and governments.

And yes, of course, they should be applauded for their outstanding performance. But where I focused my attention was on what this company, which has its pulse on the supply chain of a wide variety of products, said about the ease of doing business and where they found their biggest challenges.

The Self Fulfilling AI Based Virtuous Loop

First, the company stressed its focus on technology and database management in order to “know” its products and its customers “better than anyone else.” In effect, the company’s software (AI) is programmed to focus on key words and attributes related to each individual product it sells. Moreover, the AI is always evaluating and adapting the general sales volume for each product and the reasons why customers rely on these products.

The company then takes the data and uses to buy larger quantities of the products that sell the best, ensuring that they have plenty of what their customers want and can ship the products rapidly. The net result is that sales are maximized because their largest sales volumes are in the products that customers want the most.

In addition, they take this data and use it to shape their advertising, thus targeting the customers that are most likely to be interested in their highest selling products. They then take this data and train their sales force to maximize their knowledge base about what sells the most and to emphasize the bestselling products to their customers. Moreover, they review their best sellers periodically and adjust the list accordingly, to continue to increase their sales and their operational efficiency.

Digging Deeper

Certainly, the headlines were bullish. The company beat expectations and offered positive forward guidance. But during the question and answer period, there were some important revelations. Specifically, the company noted:

• Macro headwinds remain in place; especially the difficulty in raising prices to customers;
• Prices for products have flattened out;
• Gross margins will be flat throughout the year;
• Customer growth has been greater in the mid-size business than in large businesses;
• Shipping rates for the company have remained stable since they don’t receive cargo through the Red Sea corridor; and
• After adding 200 sales people in the last two years, going forward, the focus of the company’s expenses is the expansion of regional storage capacity and AI/technology.

Together, these finer points suggest that inflation has flattened out, especially for businesses which don’t receive cargo shipped through the Red Sea. In addition, after expanding its salesforce over the past two years, GWW is now spending its money on technology and expanding its storage capacity, via building three distribution centers (Oregon, North Carolina, and Houston). The three new centers will encompass over 2 million square feet.

Perhaps the most interesting nugget is that the company is having problems raising prices, and that its fastest growing customer segment is midsize companies, signaling that growth is now in companies which are more likely to do business in the U.S., or perhaps North America instead of on a global basis.

That’s important because it suggests that the trend toward moving businesses away from China to friendlier places is ongoing.

What it Means for Your Portfolio

A sector review reveals some interesting developments in sector specific money flows which fit what GWW told us.

For example, the Industrial Select Sector SPDR Fund (XLI), which houses GWW and other industrial companies is quietly moving higher as investors capitalize on the potential for further gains from the ongoing transformation of the global supply chain.

Note the bullish rise in the Accumulation/Distribution (ADI) indicator, usually a gauge of what short sellers are up to. In this case, they are heading for the exits, which is a welcome and bullish development. The steadiness in the On Balance Volume line (OBV) is also comforting as it’s a sign that there are more buyers than sellers in the mix.

The consolidation pattern in the SonicShares Global Shipping ETF (BOAT) goes along with GWW’s remarks about their lack of a rise in shipping costs since they don’t receive cargo through the Red Sea. This suggests that the market is taking a more wait and see attitude in this regard, especially as rumors of peace talks in the Middle East have leaked out recently. In contrast to XLI, ADI is rising but OBV is falling. This divergence reflects uncertainty in the market.

On the other hand, the SPDR S&P Transportation ETF (NYSE: XTN) is perking up as investors factor in alternative modes of transportation for cargo, such as air freight and railroads.

Bottom Line

Over the last few months, fears of supply chain disruptions and the potential for a rise in inflation due to higher shipping costs and product shortages, reminiscent of the pandemic, working their way through the system have risen. Yet, complex systems adjust, and there is emerging evidence of that adjustment.

The Q & A section of the most recent earnings call for industrial supply chain management company W.W. Grainger suggests that the supply chain situation may be less one size fits all and more situationally dependent than at first glance. In addition, the company’s lack of pricing power suggests that inflationary expectations may be overdone or at least are flattening out presently. The market’s action, via sector rotation, suggests that investors are adapting to these notions.

In the end, it’s all about what the Federal Reserve will do next. In this case, Grainger’s inability to raise prices suggests that even though the Fed is talking tough, as time passes, the odds that we’ve seen the top in rates continue to rise. And that’s bullish for stocks.

You can observe a lot, just by paying attention to earnings calls transcripts.

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