Outlook for Corporate Profits and Relative Sector Value Mark Killion, CFA World Industry Service Global Insight

Transcription

1 Outlook for Corporate Profits and Relative Sector Value Mark Killion, CFA World Industry Service Global Insight

2 Outlook for Corporate Profits Agenda: Corporate Profits are key to: understanding asset valuation, credit quality anticipating the CapEx cycle and employment growth NIPA Corporate Profits illustrate recent sector trends The cleanest measure of current operating earnings Sector data as Financial Benchmark for companies and peer groups Sector Efficiency in use of Equity and Capital Return on Equity, Gearing Ratio, Profit Margin, Dividends, ROFIC Forecast for Future Sector Profits after the bounce of 3 Which sectors enjoy the fastest growth? Comparisons with History, International, Analysts Expectations Fundamental Valuation Metrics 3 Measures of Relative Value, 3 Measures of Capital Efficiency Summary of Implications for Construction of Stock Sector Portfolio

3 Two Measures of US Corporate Profits S&P 5 US$ Earnings Per Share S&P 5 Profits, (EPS) US Corporate Profits US$ Billion E 5 E 6 E 7 E NIPA Profits (Bill.$) Two common measures of corporate profitability: 1) S&P5 Earnings Per Share (EPS) are Filings with SEC GAAP earnings on a pershare basis for 5 large companies ) US NIPA Corporate Profits are Filings with the IRS by All Companies current operating profits in Billion US$ NIPA is the cleanest measure of operating profits: counts stock options as operating expenses no management discretion in reporting, reserves no survivorship bias has both top down & bottom up consistency S&P 5 Profits from SEC via S&P (EPS, LHS) NIPA Profits from IRS via BEA (Bill.$, RHS) Source: Standard & Poor's, US BEA, G Forecasts Both profits measures are up in 3, but slower growth expected for 5 Source: Standard & Poor s, BEA, Global Insight Forecasts 3

4 Compare the Latest Profits Trends in the U.S. to the U.K. United States Corporate Profits Growth Rate (LHS), and Profits as Shares of GDP (RHS) (Percent) United Kingdom Corporate Profits Growth Rate (LHS), and Profits as Shares of GDP (RHS) (Percent) E 5 E 6 E 7 E Growth of Profits, % Profits Share of GDP E 5 E 6 E 7 E Growth of Profits, % US NIA Corporate Profits Growth (LHS) US Corporate Profits Share of GDP (RHS) 6 5 Profits Share of GDP UK NIA Corporate Profits Growth (LHS) UK Corporate Profits Share of GDP (RHS) Source: World Economic Service

5 What are the Latest Trends in European Profits? Compare Germany to France Germany Corporate Profits Growth Rate (LHS), and Profits as Shares of GDP (RHS) (Percent) France Corporate Profits Growth Rate (LHS), and Profits as Shares of GDP (RHS) (Percent) Growth of Profits, % Profits Share of GDP Growth of Profits, % Profits Share of GDP E 5 E 6 E 7 E E 5 E 6 E 7 E 13 1 Germany NIA Corporate Profits Growth (LHS) Germany Corporate Profits Share of GDP (RHS) France NIA Corporate Profits Growth (LHS) France Corporate Profits Share of GDP (RHS) Source: World Economic Service 5

6 What Has Been the Recent Profits Performance in Key U.S. Sectors? Summary from Recent Data Sectors that have Done Well: Financial, such as Mortgages, Securities, Leasing Retail, Consumer Non Durables US Earnings in Rest of World Sectors that were Hit Hard but have Since Recovered: Fabricated Metal, Other Durables Transportation, Warehousing Wholesale Trade Semiconductors & Equipment I.T. Consulting & Services Sectors Hard Hit with No Recovery Yet: Industrial Machinery, Equipment Motor Vehicles and Parts Telecommunication Services Electronics, Hardware I.T. Oil and Energy have Surged on the back of Higher Oil Prices Chemicals & related products are fairly stable but below 199s peaks due to higher oil prices Source: World Industry Service 6

7 Which U.S. Sectors Are Generating Profits? Sectors with Steady Profits Future Pressure? (Billions of US$) Rest of the World is Growing More Profitable (Billions of US$) Rest of the W orld Net Receipts from the Rest of the W orld Paym ents to the Rest of the W orld 15 Banking (In Federal Reserve System) Retail Trade FinancialNonBanking Annual 3 I I Last Quarters Annual 3 I Last Quarters I Source: US BEA 7

8 Which U.S. Sectors Are Recovering or Stalling? Sectors with Generally Steady Profits (Billions of US$) Past Weaknesses Has Turned into Recovery (Billions of US$) 7 6 U tilities Food & Related Products W holesale Trade 35 3 Fabricated M etal Products Other durable goods Transportation and W arehousing Annual 3 I I Last Quarters Annual 3 I Last Quarters I Source: US BEA

9 Which U.S. Sectors Are Recovering or Stalling? Sectors With Slow Recovery in Profits (Billions of US$) Sectors with Exposure to Oil Related Factors (Billions of US$) 3 M otor Vehicles, Bodies and Trailers, and Parts 35 Petroleum & Coal Products 1 Industrial M achinery & Equipm ent 3 C hem icals & Products I I I I Annual Last Quarters Annual Last Quarters Source: US BEA 9

10 Which U.S. Sectors Are Recovering or Stalling? Technology Sectors Still Under Pressure (Billions of US$) Company EPS is Still Weak in Technology (Sector Earnings Per Share (EPS)) 3 Info. & Com m unication Technology Com puter and Electronic products Electrical Equipm ent, Appliances, and Com ponents 15 EPS: Telecommunication Sector EPS: Information Technology Sector I I I I Annual Last Quarters Annual Last Quarters 5 15 Source: Standard & Poor s, US BEA

11 Which U.S. Sectors Are Recovering or Stalling? Semiconductors Leading Technology Hardware Recovery (Earnings Per Share (EPS)) Strength in Tech. IT & Entertainment (Earnings Per Share (EPS)) 5 3 Sem iconductors Sem iconductor Equipm ent 15 System and Aplication Software In te rn e t s o ftw a re a n d S e rv ic e s IT Consulting and Services H o m e E n te rta in m e n t S o ftw a re Com puter Hardware and Storage I I I I Annual Last Quarters Annual Last Quarters Source: Standard & Poor s, US BEA 11

12 Which US Sectors Are Generating Profit Growth? Latest Earnings Per Share Postings by S&P 5 Companies 1 Year Historical Earnings Per Share (EPS) Growth for US Sectors Ranked by Slowest to Fastest $EPS Gain (Latest Quarter EPS Dollar Increase over Previous Quarters: Q3 3 through Q EPS minus Q3 through Q 3 EPS ) Telecom s Consum ers Staples Health Care In d u s tria ls S&P 5 Total is 1.56 Telecoms Consumer Staples Health Care Industrials Q $EPS for U.S. Sectors S&P 5 Total is 15. Materials Materials U tilite s Utilities Financials Financials Technology Energy Consum er Dioscretionary Technology Energy Consumer Discretionary Latest Quarter EPS D ollar Increase over Previous Quarters (Q3 3 through Q EPS minus Q3 through Q 3 EPS) Q EPS Source: Standard & Poor s 1

13 Return On Equity shows rate of return that management earns on capital provided by the shareholders US Corporate Return on Equity Total for US Corporations in the GICS Sector Classification Scheme DuPont System ROE Framework shows the rate of return that management earns on capital provided by the shareholders (Profits calculated relative to the equity interest, after accounting for payments to all other capital suppliers) ROE Framework: Return on Equity (NI/Equity) = ROE (%) LHS Margin (%) RHS Financial Leverage (Ratio) RHS Asset Turnover (Ratio*) RHS 3 3 Profit Margin (NI/Sales) * Asset Turnover (Sales/Assets) * Financial Leverage (Asset/Equity) Where: NI = Net Income; Equity = Book Value of Equity, Valued at the End of the Preceding Period; Assets are Total Current Period; Sales are Gross; ( * Denotes a multiplication sign) Source: Worldscope Company Financial Statements & WIS Calculations 13

14 Return On Equity For Continental Europe and the U.K. Continental Europe Corporate Return on Equity Total for 5 Corporations in the GICS Sector Classification Scheme United Kingdom Corporate Return on Equity Total for 5 Corporations in the GICS Sector Classification Scheme ROE (%) LHS Margin (%) RHS Financial Leverage (Ratio) RHS Asset Turnover (Ratio*) RHS ROE (%) LHS M a r g in (% ) R H S Financial Leverage (Ratio) RHS Asset Turnover (Ratio*) RHS Source: Worldscope Company Financial Statements & WIS Calculations 1

15 What is the Sector ROE Performance? Long Run Historical ROE for US and European Sectors Ranked by European Perspective Largest to Smallest (Average ROE for US & European Sectors (X UK), Average over 1993, Top GICS Economic Sectors) Consumer Staples Health Care Financials Industrials Energy Total Consumer Discretionary Utilities Materials Information Technology Telecommunication Svs Europe United States Source: Worldscope Company Financial Statements & World Industry Service (WIS) Calculations 15

16 How To Measure Financial Leverage? Measures of Financial Leverage (Financial Multiplier, Gearing Ratio and Interest Expense Ratio) US Totals for All Non Financial European (X UK) Totals for All Non Corporations in the GICS Sector Financial Corporations in the GICS Classification Scheme Sector Classification Scheme D/E On RHS Scale Interest Expense as % of Total Expense Financial Leverage Ratio (Asset/Equity) Ratio of Debt to Equity (RHS) Interest Expense as % of Total Expense Financial Leverage Ratio (Asset/Equity) Ratio of Debt to Equity (RHS) Source: Worldscope Company Financial Statements & WIS Calculations 16

17 Federal Reserve Flow of Funds Accounts for US: Net Issuance of Corporate Equity and Debt US Corporate Business (Non Farm Non Financial) Net Issue of Debt and Equity (Billion US$; Quarterly figures are seasonally adjusted annual rates) r I 3 I 3 3 I I N et increase in N ew Eq uity Issues N et increase in C red it M arket B o rro w ing Source: Board of Governors of the Federal Reserve System 17

18 Which Sectors have the Highest Gearing Ratio? Sector Ratio of Debt to Equity Sector Financial Leverage Measured as Ratio of Debt to Equity US Sectors with High Debt to Equity Ratios European Sectors with High Debt to Equity Ratios Telecoms Consumer Discretionary Utilities Industrials Telecoms Consumer Discretionary Utilities Industrials Source: Worldscope Company Financial Statements & WIS Calculations 1

19 Which Sectors have the Highest Profit Margins? Sector Ratio of Operating Profits to Sales Sector Profits Margins: Average Operating Profits as a % of Sales Sectors with the Highest Profit Margins: Ranked by U.S. Average 1993 Operating Profits as a % of Sales Manufacturing Transport. & Communication Retail & Wholesale Trade Mining All Sectors Construction Utilities Agriculture Financials US West Europe Fertilizers & Pesticides Business & Professional Svs Retail Trade, Vehicles Related Motorcycles & Bicycles Soap & Clean. Preparations Shipbuilding Drugs & Medicines Equipment Leasing Real Estate US West Europe Source: World Industry Service 19

20 How Do Sector Profits Move over the Business Cycle? Operating Profit Margin for U.S. Food Manufacturing & Industrial Machinery excl. Electr for U.S. Food Manufacturing & Industrial Machinery excl. Electrical Food M anufacturing Industrial M achinery Source: World Industry Service

21 Sector Operating Characteristics: Degree of Operating Leverage How Do Sector Profits Change with Sales Growth? Sector Beta Relating WIS Sector Profits Growth to WIS Sector Sales Growth, Where a Number Above 1 Shows Higher Leverage, Below 1 Shows Lower Leverage (199) ) Degree of Operational Leverage (DOL) summarizes how changes in sales growth affect profits growth US World Excluding US DOL reflects mix of fixed costs versus variable costs in operations 1. 1 Sectors with high fixed costs and CapEx Requirements have higher DOL..6 DOL is often higher in U.S. than in ROW DOL in U.S. has been on a rising trend.. Total Energy Materials Industrials Consumer Discretionary Consumer Staples Health Care Financials Information Technology Telecoms Utilities Source: World Industry Service 1

22 How Do Sector Profits Change with Sales Growth? U.S. Degree of Operating Leverage (Percent change of profits divided by percent change in sales, 3year moving average).5 Financial Non Financial Source: World Industry Service

23 Outlook for Sector Profits Growth: United States and Europe 5 Year Profits Growth for the Mature Phase of U.S. Business Cycle (Average Percent Growth of Operating Profits, Forecast for 9, Broad Economic Sectors in GICS) Information Technology Health Care Industrials Financials Total Telecommunication Svs. Consumer Discretionary Consumer Staples Utilities Materials Energy 6 Percent Growth of US $ Sector Profits Percent Growth of EU Euro Sector Profits Source: World Industry Service 3

24 Outlook for US Profits Growth: Role of Financial Versus Non Financial Sectors US Historical and Forecast Long Term Sector Profits Growth Average Percent Growth of Operating Profits in the US 1 6 Total Non Financial Financial Source: World Industry Service

25 Outlook for West European Profits Growth: Role of Financial Versus Non Financial Sectors Europe Historical and Forecast Normalized Sector Profits Growth Average Percent Growth of Operating Profits in West Europe In Euros Total Non Financial Financial Source: World Industry Service 5

26 US and EU Sector Profits Outlook Measures of Long Term Normalized Sector Profits Growth (Average Percent Growth of Operating Profits in the US and EU, History for 1995 and Forecast for 59) Percent Growth of US $ Sector Profits Percent Growth of EU EURO Sector Profits Total Utilities Telecoms Inform.Technology Financials Health Care Co nsumer Staples Co ns. Discretio nary Industrials M aterials Energy Total Utilities Telecoms Info rm.techno lo gy Financials Health Care Consumer Staples Cons. Discretionary Industrials Materials Energy Source: World Industry Service 6

27 U.S. Comparison of 3 Year Forecasts for Sector Sales: WIS Forecast Versus Analysts Consensus Estimates Consensus Estimate v. WIS Forecast Three Year Growth in US Sector Sales, US$ (7) 6 6 Energy Materials Industrials Cons. Discr WIS Cons. Staples Health Care Financials IT Consensus Telecoms Utilities Total Consensus Estimates of Sales Forecasts are the arithmetic average among reporting analysts of their estimates for company sales growth Company Sales Estimates are extracted from the Thomson First Call & aggregated to Sector Totals by WIS These data use analyst s estimates that were submitted anytime during the current FY The Consensus Estimates for Sales for this time period covers 97 Companies out of a possible 776 Source: Thomson Financial First Call & WIS Calculations 7

28 U.S. & West Europe 3 Year Forecasts for Profits WIS Forecast Versus Analysts Consensus Estimates Consensus Estimate v. WIS Forecast Three Year Average Growth in All Sector Profits (7) United States in $ US Europe in $US Europe in Euros WIS Consensus Source: Thomson Financial First Call & WIS Calculations

29 U.S. & West Europe 3 Year Forecasts for Sector Profits: WIS Forecast Versus Analysts Consensus Estimates Three Year Growth in US Sector Profits, US$ (7) Three Year Growth in Western Europe Sector Profits, Euros (7) Energy Materials Industrials Cons. Discr WIS C ons. S taples Health Care Financials IT Telecoms U tilities Consensus Total 6 Energy Materials Industrials Cons. Discr WIS Cons. Staples Health Care Financials IT Telecoms Utilities Consensus Total Source: Thomson Financial First Call & WIS Calculations 9

30 Total How Much to Pay for US Earnings Growth? Price to Earnings Ratio (P/E) Adjusted for Forecast Growth (PEG) Sector Stock Price Valuation Metric: P/E Adjusted for Sector Profits Growth Forecast (PEG) (S&P Data for P/E is as of October1 (with Earnings Estimated); Forecast of Profits Growth 9) 9 P/E Ratio P/E /Growth (PEG Ratio) Energy Basic Materials Industrials Cons. Discretionary Cons. Staples Health Care Financials Technology Telecomm. Svs. Utilities Total Energy Basic Materials Industrials Cons. Discretionary Cons. Staples Health Care Financials Technology Telecomm. Svs. Utilities Source: S&P, World Industry Service

31 How Much to Pay for US Dividend Earnings? Current Dividend Yield and Historical Dividend Growth Rates Dividend Yield U.S. Sectors Q (Dividend Payment per share divided by the Stock Purchase Price per share) Dividend Growth U.S. Sectors (Average Compound Growth Rate of Dividends Paid) 3 1 Technology Consumer Discr. Health Care Industrials Consumer Staples Materials Financials Energy Telecoms Utilities Source: Worldscope Company Financial Statements & WIS Calculations 31

32 Expected Return from Dividend Discount Model Current Dividend Yield plus Long Term Growth Rate Forecast of Dividend Payments 6 Total Expected Return from Investment in US Sectors (S&P Data for Dividend Yield from Q, Forecast of Dividend Growth 9) TOTAL Financials Materials Industrials Consum er Discretionary Consum er Staples Health Care Technology Telecom s Utilities Dividend Yield Dividend Growth Forecast Source: S&P, World Industry Service 3

33 Dividend Policy & Corporate Investment Spending Dividend Payout Ratio and CapEx share of GDP Dividend Payout Ratio for US Sectors Average S&P 5 Earnings Retention Ratio and US Private Fixed Investment Share of GDP % 75 9% % 7% 6% 5% % 3% % EarningsRetention Ratio (%) CapEx/GDP (%) % % Retention Ratio CapEx share of GDP Source: S&P, Worldscope Company Financial Statements & WIS Calculations lations 33

34 What Sectors Require High CapEx Spending? US CapEx Spending as % of Total Sales Total for 775 US Corporations in the GICS Sector Classification (Average 1993, United States) CapEx Spending as % of Total Sales United States Vs Europe, (3) TOTAL Non Financial Financials Energy Materials Industrials Cons. Discr. Cons. Staples Health Care Technology Telecoms Utilities Financial (LHS) Non Financial (RHS) US West Europe Source: Worldscope Company Financial Statements & WIS Calculations 3

35 What is the Return on Fixed CapEx Spending? (ROFIC) 1 US Corporate Sector: Return from Investment in Fixed Capital Company Net Income / 3year 3 sum of Fixed Investments 5 3 US Macro Economy: Marginal Efficiency of Private Fixed Investment in GDP / 3year 3 sum of Fixed Investments Financial Non Financial 3 GD P / P r ivate Fixed C ape x GD P / C ape xe quipment & Sof tw ar e Source: US BEA, Worldscope Company Financial Statements & WIS Calculations 35

36 What is the Sector Return on CapEx Spending? (ROFIC by Sector) Corporate Return on Fixed Investment Spending by Sector 3 Company Net Income / 3year 3 sum of Fixed Investments TOTAL Non Financial Financials Energy Materials Industrials Consum er Discretionary Consum er Staples Health Care IT Telecom s Utilities US West Europe Source: Worldscope Company Financial Statements & WIS Calculations 36

37 U.S. Stock Prices Correlate Well with ROFIC US Corporate Return on Fixed Investment (Average 19963) and the Percent Change in Stock Prices (Average Annual Percent Change 1996 (Average Annual Percent Change 19963) Energy M aterials Industrials Consum er Discretionary ROFIC (Net Income/Capex) Consum er Staples Health Care Financials 19 Information Technology Telecoms Utilities Average Growth in Stock Price Index Source: Worldscope Company Financial Statements, Standard & Poor s s Stock Price Indexes & WIS Calculations 37

38 Summary of Fundamental Valuation Metrics for a Portfolio of Sectors in the U.S. Stock Market Which Measures Point to an Overweight (), Underweight ()( ) or Neutral(=) Position for Sectors within a US Stock Market Portfolio? Energy Materials Industrials Cons. Discr. Cons. Staples Health Care Technology Financials Telecomms Utilities P/E = PEG = Div. Yield = = = DDM = ROE ROFIC 3

39 Thank you! Mark Killion, CFA World Industry Service Global Insight Tel: