Zacks Earning Trends

Transcription

1 March 5, 2015 Zacks Earning Trends Sheraz Mian Closing the Books on Q4 Earnings Season With just a handful of reports still to come, the Q4 earnings season has effectively ended. The focus will shift in the coming days to the 2015 Q1 earnings season, as companies with fiscal quarters ending in February start coming out with results. We count these companies, which includes such major players like Adobe (ADBE), Nike (NKE) and FedEx (FDX), as part of our Q1 tally. Estimates for the current and following quarter have taken a severe beating in recent weeks, with a combination of Energy sector weakness, dollar strength and global growth worries resulting in a complete evaporation of growth estimates for the year as a whole. The chart below shows what is happening to 2015 Q1 and Q2 earnings estimates for S&P 500 companies. Energy is obviously the biggest drag on estimates for the first half of the year, but estimates beyond the Energy sector are also coming down. The hope is that over time we will start seeing the savings from lower energy prices show up in other sectors, particularly the retail and discretionary sectors. Those stocks have been showing these favorable expectations, though we have yet to see that show up in estimates.

2 Q4 Earnings Scorecard (as of March 5th, 2015) We now have Q4 results from 493 S&P 500 members, with total earnings for these companies up +6.9% from the same period last year, with 65.1% beating earnings estimates. Total revenues are up +1.7%, with 54.5% beating top-line estimates. Comparing the Q4 results with what we have been seeing from the same group of companies in other recent quarters in terms of growth rates, beat ratios, and guidance presents a mixed picture. The charts below show the comparison of the results thus far with what we have seen from this same group of companies in other recent quarters. We have discussed the Apple effect in this space before and the effect is very pronounced. The charts below provide a side-by-side comparison of the Q4 earnings and revenue growth rates for the 493 S&P 500 companies that have reported results, with and without Apple in the numbers (the left side is with Apple and the right side is excluding Apple). The comparisons are with what we have seen from the same group of companies in 2014 Q3 and the average of the preceding four quarters. 2

3 We should keep in mind however that Apple isn t the only unusual factor this earnings season. Results from the Finance sector have been a drag on the aggregate growth picture as well. And then we have the whole oil situation, with profitability of the Energy sector companies following what has been happening to oil prices. The chart below shows the results thus far excluding the effect of Apple and the Energy sector. As you can see, the earnings growth picture is broadly comparable with historical levels on this basis. But irrespective of whether we look at the results as a whole or piecemeal, the weakness on the revenue side comes through revenue growth rate is tracking below other recent quarters whether we look at the results with or without Apple, Finance or Oil. Retail Sector Results The Retail sector dominates the later part of each reporting cycle and that has been the focus lately in the ongoing Q4 earnings season as well. There is some improvement in 3

4 the sector s earnings picture, likely a function of lower oil prices. But the gains aren t as pronounced as one would expect from the market s favorable reaction to the sector results thus far. Please note that Retail sector stocks are up the most compared to any other sector in response to Q4 results. With results from 95.2% of the sector s market cap in the S&P 500 index already out, total Retail sector earnings are up +6.1% on +5.2% higher revenues, with 69.4% beating consensus EPS estimates and 52.8% beating top-line estimates. Except for the lower ratio of retailers beating revenue estimates, the earnings and revenue growth rates and the earnings beat ratios are modestly better than what we have been seeing from the same group of retailers in other recent quarters. The chart below provides a comparison of the results for the 36 Retail sector companies in the S&P 500 index (out of 42 retailers in the index in total) with what we had seen from the same group of 36 retailers in 2014 Q3 and the average of the preceding four quarters. The chart also spotlights the sector s persistent margin woes (earnings growth is less than half the top-line gain), a function of the extremely promotional environment that all industry players have been complaining about. The issue will likely get even more pronounced with the Wal-Mart (WMT) pay-hike announcement pressuring others like Target (TGT) to follow suit. (Full report on next page) 4

5 Q4 Earnings Season Effectively Over The 2014 Q4 earnings season is fast winding down, with results from 493 S&P 500 companies already out. Total earnings for the these 493 companies are up +6.9% from the same period last year, with 65.1% beating expectations. Total revenues for these companies are up +1.7%, with 54.5% beating revenue expectations. The table below provides a Scorecard for the 493 companies that have reported results, as of the Thursday, March 5th, Note: Here are few key points to keep in mind while reading this report. a. All the earnings analysis in this report pertains to the S&P 500 index, a handy proxy for the entire business world. b. We divide the corporate world into 16 sectors compared to the official S&P 10 GICS. We have standalone sectors like Autos, Construction, Conglomerates, Aerospace, Transportation and Business Services that provide for a better understanding of trends in these key areas of the economy. 5

6 c. All references to earnings mean total earnings and not median EPS. d. We make adjustments to reported GAAP earnings to account for non-recurring or one-time items, but we do consider employee stock options (ESOs) as a legitimate business expense. Unlike Zacks, Wall Street and all other data vendors don t treat ESO s as a recurring business expense. As you can see, the earnings season has ended for fourteen sectors, while the remaining two sectors (Consumer Disc, and Retail) have more than 95% of their members report results already. Retail is the only sector at this stage that has a meaningful number of reports still awaited. But even for Retail, we have already seen from results from 95.2% of the sector s total market cap in the S&P 500 index. In other words, the Q4 earnings season is effectively in the rearview mirror at this stage, particularly for the S&P 500 Index. For small-cap companies, there are still plenty of reports to come. For the Russell 2000 index, the Q4 earnings season is over for just over 80% of the index members, with the rest still awaited. We discussed earlier the mixed comparison of the results thus far relative to other recent periods due to the Apple and Finance sector results. Let s compare the results for the Finance and Tech sectors at this stage. For the Finance sector, total earnings are up only 0.1% on +0.9% higher revenues, with 64.2% beating EPS estimates and 59.3% coming ahead of revenue expectations. The table below shows the sector s scorecard at the M-industry level. The charts below compare the Finance sector results thus far with what we have seen from the same group of companies in other recent quarters. 6

7 Except for the earnings beat ratio, this is the weakest performance from the sector at this stage, at least in the past one year the growth rates are lower and fewer companies are beating revenue estimates. Are Tech Sector Results Really Strong? The earnings season has ended for the Technology sector as well, with total earnings for the sector up +13.5% from the same period last year on +7.9% higher revenues, with 64.5% beating EPS estimates and 48.4% coming ahead of top-line estimates. Aside from the revenue beat ratio, this is better performance than we have seen from the same group of Tech sector companies in other recent quarters. The table below provides the sector s Q4 scorecard at the M-industry level. The chart below compares the Tech sector results thus far from what we have seen from this group of companies in other recent quarters 7

8 We should keep in mind however that Apple s blockbuster report is carrying an outsized effect in the sector s aggregate picture at this stage. The sector s growth picture isn t as inspiring once Apple is excluded from the numbers. The chart below reproduces the growth comparison chart from above (the left side of the two-chart set above) on an ex-apple basis. The Composite (or Blended) Picture for Q4 For the S&P 500 as a whole (combining the results from the 493 companies that have reported with estimates for the remaining 7), total earnings in Q4 are expected to be up +6.9% from the same period last year, on 1.8% higher revenues and modestly higher margins. Estimates came down as the quarter unfolded, with the magnitude of negative estimate revisions for Q4 the highest relative to other recent quarters. The current +6.9% growth expected in Q4 has been slowly creeping up in recent days as companies come out with better than expected results in the customary fashion, but it is nevertheless down 8

9 from 9.6% at the start of the quarter in early October. Estimates for 7 of the 16 Zacks sectors came down, with Consumer Staples, Consumer Discretionary, Medical, Autos, Conglomerates, Technology, Aerospace, Utilities, and Construction as the only ones that experienced modest positive revisions. Negative revisions were particularly pronounced in the Energy, Basic Materials, Finance and Industrial Products. The table below provides a summary view of the expectations for 2014 Q4. As you can see, Energy remains a drag on the Q4 earnings growth rate. Total earnings growth in the quarter outside of the Energy sector is at +9.3% from the same period last year. Falling 2015 Q1 Estimates As has been the case for quite some time, estimates for the current and following quarters have been coming down at an accelerated pace under the combined effect of low oil prices, the strong U.S. Dollar and weak global growth. The current expectation of 9

10 -4.9% total earnings decline in Q1 is down from estimates of +10.8% growth in early October. In fact, the magnitude of negative revisions for Q1 is more pronounced than we had seen at comparable stages in other recent quarters. As shows earlier, the chart below shows how growth estimates for the first and second quarters of 2015 have evolved since early October. As you can see, the strong positive growth expected earlier has totally disappeared. Oil is undoubtedly the biggest culprit here, but the revisions picture isn t that much better on an ex-oil basis either, as the chart below shows 10

11 The Context for Growth Expectations Let s take a look at how consensus earnings expectations for 2014 Q4 compare to what companies earned in the last few quarters and what they are expected to earn in the coming quarters. Table 2 below presents the year over year earnings growth rates - expectations for Q4 and the following three quarters. It also shows consensus earnings growth expectations for 2014 and Table 3 presents the same data for revenues. Table 2 Earnings Growth Context 11

12 Table 3 Revenue Growth Context Note: Lack of consensus revenue estimates, particularly for a number of key Finance sector companies such as Berkshire Hathaway, makes consensus projections for the sector less precise. Data for all the other sectors is fairly reliable. As such, we suggest using the ex-finance growth rate as a proxy for the index as a whole. The next two tables present the same data in a different format instead of year-overyear growth rates, we have the dollar level of total earnings and revenues for each of these quarters. 12

13 Table 4 Total Quarterly earnings 13

14 Table 5 Total Quarterly Revenues It may be obvious, but it s still useful to explain what we mean by total earnings. This means the sum total of aggregate earnings for all the companies in the S&P 500. For historical periods through 2014 Q3, we have taken the total earnings (not EPS) for each company in the S&P 500 and added them up to arrive at the sector and index level totals (we do adjust reported GAAP earnings for non-recurring items, but consider employee stock options as a legitimate business expense). For the coming quarters, we have taken the Zacks Consensus EPS for each company in the index, multiplied that by the corresponding share count (from the last reported quarter) to arrive at the total earnings for each company. And then we aggregated them to arrive at the totals for each sector and the index as a whole. The lack of accuracy in real-time share count notwithstanding, this gives us a fairly accurate view of the total earnings picture. 14

15 In plain language, what Table 4 tells us is that companies in the S&P 500 earned $285.8 billion in 2014 Q3 and the tally is on track to reach a new all-time record of $292.2 billion Q4 14. The sharp revisions to estimates for the next three quarters notwithstanding, total earnings are expected to reach a new all-time record at $297.4 billion in Q4 15. The Margins Picture Net margins (total earnings/total revenues) are expected to be down in 2014 Q4 from the preceding quarter, but they are up year over year. The table below shows net margin expectations for Q4 in the context of where they have been and where they are expected to go in the coming quarters. Table 6: Quarterly Net Margins The table 7 below shows net margins on a trailing four-quarter basis. So, the 10.1% net margin for 2014 Q2 reflects estimates for Q2 and actuals for the preceding three quarters, and so on. 15

16 Margins follow a cyclical pattern. They expand as the economy comes out of a recession and companies use existing resources in labor and capital to drive business. But eventually capacity constraints kick in, forcing companies to spend more for incremental business. At that stage, margins start to contract again. We may not be at the contraction stage yet, but we do need to buy into fairly optimistic assumptions about productivity improvements for current consensus margin expansion expectations to pan out. Market Cap vs. Total Earnings The charts below show the share of total earnings for 2014 as well as the share of total market capitalization for each of the 16 Zacks sectors. Since the S&P 500 is a marketcap weighted index, each sector s market cap share is also its index weight. Finance has regained its leadership position in the index in terms of earnings contribution, though it still remains significantly below its record 27% share of the index earnings in The sector lost its leadership position to Technology in the wake of the global financial crisis, but got it back in 2013 and remains on track to retain the position this year and next. 16

17 The Finance sector is an even bigger contributor to the S&P 600 index, expected to bring in 26.5% of the small-cap index s total earnings in And unlike the S&P 500 where the Technology sector has the larger market cap, Finance is the biggest market cap contributor to the S&P 600 index. % Share of Mkt Cap Consumer Discrt 5.1% Retail 9.1% Medical 13.8% Consumer Stapls 7.4% Auto/Tires/Trks 1.4% Transportation 2.1% Utilities 4.9% Business Svcs 3.4% Industrial Prod 2.1% Basic Materials 2.8% Construction 0.7% Conglomerates 3.1% Finance 15.9% Computer & Tech 18.9% Oils/Energy 7.7% Aerospace 1.6% 17

18 Share of 2014 Income Consumer Discrt 4.6% Consumer Stapls 6.5% Retail 7.2% Medical 13.5% Auto/Tires/Trks 2.2% Basic Materials 2.8% Transportation 2.3% Business Svcs 2.7% Industrial Prod 2.3% Construction 0.7% Conglomerates 3.4% Utilities 5.8% Computer & Tech 18.3% Finance 21.0% Want more information about this report or about Zacks Investment Research? Contact Terry Ruffolo at or at Visit the Zacks Media Room at zacks.com/media-room Oils/Energy 5.0% Aerospace 1.7% Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. 18