August 18, 2016 Zacks Earning Trends Sheraz Mian SMian@Zacks.com Retail Improves, But Issues Still Remain The bulk of the Q2 earnings season is now behind us, with results from 474 S&P 500 members already out. Total earnings for these companies are down -3.3% on +0.1% higher revenues relative to the same period last year, with 71.7% beating EPS estimates and 53.8% coming ahead of top-line expectations. The focus lately has been on the Retail sector, with a number of leading operators like Wal-Mart (WMT), Macy s (M), Nordstrom (JWN) and others coming out with positive surprises and a favorable outlook. These positive reports notwithstanding, the sector s overall earnings performance is still on the weak side. Driving this weakness has been the steady decline in foot traffic as a result of sales moving online. With many of these operators struggling to deal with this shift in consumer behavior, Amazon (AMZN) has been able to gain share by offering a compelling user experience. Amazon s steady gains in the apparel space is a big reason for the pain in the traditional department store space. The positive results from the likes of Macy s and others this earnings season is not reflection of a better competitive response to Amazon & Co, but largely a function of factors that will likely not endure beyond the next couple of quarters. These factors include improvement on the inventory front and very low department store expectations. Inventories finally appear to be in-line with sales, which comes after two back-to-back quarters when these operators were saddled with mountains of unsold merchandize as a result of weather and the aforementioned reduced foot traffic issue. Unlike the department stores, the improvement in Wal-Mart results appear to be more enduring, with the retail giant not only doing a better job at improving its core physical retail operations (cleaner stores, better assortment, and improved customer experience), but also coming out with a credible digital response to the Amazon challenge. Wal-Mart s online efforts still have a long way to go, but they have been doing a lot more on that front, even prior to the Jet.com purchase, than most of its peers. Retail Sector Scorecard We now have Q2 results from 34 of the 44 retailers in the S&P 500 index that combined account for 91.4% of the sector s market capitalization in the index. Total earnings for these retailers are up +4.0% from the same period last year on +4.3% higher revenues, with a below index average 55.9% beating EPS estimates and a very low beat ratio of 38.2% coming ahead of revenue estimates. www.zacks.com
The side-by-side charts below compare the results thus far with what we have seen from the same group of retailers in the recent past. As you can see, the earnings and revenues growth rates in the left hand chart are about in-line with historical periods. But the proportion of retailers coming out with positive EPS and revenue surprises in the right hand side chart are tracking significantly below historical periods. In other words, while growth is about in-line with historical periods, but this is weaker than what was expected. We know that Amazon had a blockbuster earnings report, which is likely giving the growth pace a helping hand. Taking the Amazon results out of the Retail sector results thus far, total earnings for the rest of the space are actually down -0.2% from the same period last year on +2.6% higher revenues. The charts below show the growth comparison, with and without the Amazon earnings report This shows that the retail sector s respectable growth pace at this stage is solely due to the Amazon report. Once we take Amazon out of the sector s results at this stage (right hand side chart), then the sector s growth pace turns out be a lot weaker. www.zacks.com 2
Q2 Earnings Season Scorecard For Q2 as a whole, we now have results from 474 index members, with total earnings for these companies down -3.3% on +0.1% higher revenues relative to the same period last year. The side-by-side charts below compare the results from the 474 index members with what we saw from the same group of companies in other recent periods. The left-hand chart compares the earnings and revenue growth rates with historical periods while the right-hand chart is doing the same comparisons for positive EPS and revenue surprises. Here are the four takeaways from the results thus far: First, earnings growth remains negative, but is nevertheless an improvement over what we saw from the same group of 474 S&P 500 members in the preceding quarter (2016 Q1) and the 4 quarter average. We may be putting too fine a point by calling a decline of -3.3% as an improvement over a decline of -4.5% (the 4-quarter average), but the Q2 decline is nevertheless an improvement over the preceding quarter. Second, revenue growth is ever so slightly in the positive (+0.1%) for this group of 474 index members. As is the case with earnings growth for these companies, it is an improvement over what we saw from this group of 474 S&P 500 members in 2016 Q1 and the average for the preceding four quarters. These earnings and revenue growth comparisons largely remain in place even after we exclude the Energy sector s substantial drag from the reported results. Total earnings for the Energy sector are down -78.9% on -24.4% lower revenues from the same period last year. Excluding the Energy sector, earnings for the remainder of S&P 500 members that have reported results would be up +0.3% from the same period last year on +3.0% higher revenues. www.zacks.com 3
The comparison charts below show the growth picture with and without the Energy sector. Third, positive EPS surprises for the 474 index members that have reported results are tracking modestly above the 4- and 12-quarter averages. This suggests that Q2 estimates may not have been that low after all. Positive revenue surprises, on the other hand, are moderately tracking below other historical periods. Fourth, estimates for the current period (2016 Q3) have come down, following a wellestablished historical trend. Total Q3 earnings for the S&P 500 index are currently expected to be down -2.8% from the same period last year, which is a decline from expectations of flat earnings at the start of the quarter. The chart below shows the evolution of Q3 earnings growth expectations www.zacks.com 4
Please note that while the trend of negative revisions to Q3 estimates is in-line with the recent past, the magnitude of negative revisions is not. In other words, estimates for Q3 are not falling by as much as was the case at the comparable stages in other recent reporting cycles. Estimates for all 16 sectors have come down since the beginning of July, but they have come down the most for the Auto sector and the least for the Technology sector. The Auto sector weakness is primarily a function of sharp drop in Ford s (F) estimates while Technology s relatively improved estimates revision picture is due to positive momentum for Facebook (FB) and Alphabet (GOOGL) offsetting modest declines at other sector players. Estimates Beyond Q2 The chart below shows (the blended) Q2 growth expectations contrasted with what was actually achieved in the preceding four quarters and estimates for the following four periods. Full-year 2016 earnings growth expectations have now turned negative, similar to what we saw last year. www.zacks.com 5
Beyond the current period (September quarter), meaningful growth is expected to resume from Q4, which is then expected to continue into 2017. Easier comparisons for the Energy sector arrive in Q4, when the sector s earnings growth turns positive. But the expected growth in Q4 and beyond isn t solely a function of easy comparisons for the Energy sector the expectation is for positive momentum from a broad cross section of sectors. Those expectations will most likely need to come down. But it will be interesting to see to what extent they will have to come down. Q2 Earnings Season Now Largely Behind us Including all of this morning s reports, we now have Q2 results from 474 S&P 500 already. Total earnings for these companies are down -3.3% from the same period last year on +0.1% loss in revenues, with 71.7% beating EPS estimates and 53.8% coming ahead of top-line expectations. The table below shows the updated Q2 Scorecard. www.zacks.com 6
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. We use the index s current membership as the basis for all period comparisons, meaning that even historical periods reflect the index s current membership. 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. c. All references to earnings mean total earnings and not mean or 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. The first column of this table shows the percentage of each sector s members in the S&P 500 index have already reported results. As you can see, the Retail sector is the only sector at this stage that has any sizable number of reports still awaited at this stage, with the reporting cycle coming to an end for ten sectors already. www.zacks.com 7
Sectors with the highest growth rates include Conglomerates (earnings are up +20.6% on -0.1% revenues), Autos (+16.3% earnings growth on +5.2% higher revenues), and Utilities (+8.3% earnings growth on -1.5% lower revenues). Of these three, only Auto sector reports have been better than expected, with 81.8% beating EPS estimates and 72.7% beating revenue estimates. The Construction sector has the lowest proportion of positive EPS surprises of all 16 Zacks sectors, while revenue beats percentages for the sector is the second lowest (the lowest revenue beat percentage of all 16 sectors is for the Retail sector). The sectors with the highest proportion of positive surprises include Medical and Technology. The Finance Sector For the Finance sector, we have seen result from 100% of the sector s total market capitalization. Total earnings for these Finance sector companies are down -5.2% from the same period last year on +1.8% higher revenues, with 66.7% beating EPS estimates and 54.4% coming ahead of revenue estimates. The chart below compares the sector s Q2 results thus far with what these same companies had reported in other recent periods. As you can see, while the growth picture isn t much to write home about, results have nevertheless been better than expected. The proportion of finance companies coming out with positive EPS and revenue surprises is far more numerous than has been the case in the past. With respect to earnings and revenues growth rates, while earnings growth is about in-line with the preceding period, revenue growth is tracking above the prior-quarter s level. Technology Sector www.zacks.com 8
For the Technology sector, we have seen Q2 results from 93.9% of the sector s total market capitalization in the S&P 500 index. Total earnings for these Tech companies are down -0.3% from the same period last year on 2.9% higher revenues, with 83.3% beating EPS estimates and 74.1% proportion beating revenue expectations. The chart below compares the results thus far with what we saw from the same group of Tech companies in other recent periods. The Tech sector s growth remains challenged whether we look with or without Apple, as the iphone maker s June quarter earnings were -27% below the year-earlier level on - 14.6% lower revenues. But as you can see in the right-hand chart, positive surprises are notably tracking above historical periods. The proportion of Tech sector companies beating revenue estimates is currently the second highest within the index (behind Medical). For the Transportation sector, we now have results from 100% of the sector s total market cap in the index. With results from all the major airlines and railroad operators already out, the sector s earnings are down -12.4% on -1.4% lower revenues, with 66.7% beating EPS estimates and only 40% beating revenue expectations. Growth is strong for the Auto sector, primarily reflecting GM s robust numbers. Total earnings for the 100% of the sector s market cap that has reported results are up +16.3% on +5.2% higher revenues, with 81.8% beating EPS estimates and 72.7% beating revenue estimates. Results from the Medical sector are particularly strong at this stage of the reporting cycle. With results from 95.4% of the Medical sector s market cap in the S&P 500 index already out, total earnings are up +5.0% on +9.2% higher revenues, with 88% beating EPS estimates and 82% beating the revenue estimates. www.zacks.com 9
The Construction sector s growth has been very strong earnings are up +7.5% on +4.7% higher revenues, with 100% of the sector s market cap in the index reporting results. But this growth was largely expected. The proportion of Construction sector companies beating EPS and revenue estimates is 38.5% and 30.8%, respectively. Expectations for the Quarter as a Whole For Q2 as a whole, total earnings are expected to be down -3.2% from the same period last year on -0.4% lower revenues. Estimates came down as the quarter unfolded, with the current expected -3.2% decline down from +0.5% growth in early January. But as referred to earlier, the magnitude of negative revisions that Q2 estimate suffered has been below what we have been seeing in other recent periods. The table below provides a summary view of the expectations for 2016 Q2 www.zacks.com 10
As you can see in the table above, the Energy sector remains a big drag on the aggregate growth picture. Total earnings for the sector are expected to be down -78.9% from the same period last year on -26% lower revenues, which follows the -108.6% drop in the sector s earnings in the preceding period. Excluding the Energy sector, total earnings for the rest of the S&P 500 index would still be modestly in the positive. In total, earnings growth is expected to be negative for 6 of the 16 Zacks sectors in Q2, with Basic Materials, Aerospace, and Transportation as the other double-digit decliners. On the positive side, 10 sectors are expected to have positive earnings growth in Q2. These include Consumer Staples (+1.3%), Consumer Disc (+5.8%), Retail (+4.1%), Autos (+16.3%), Construction (+7.5%), Conglomerates (+20.6%), Technology (+0.2%), Utilities (+8.3%), Medical (+4.7%), and Business Services (+6.0%). The growth picture isn t that reassuring for the Technology and Finance sectors in the index, with Tech earnings expected to be up slightly +0.2% with higher revenues +2.7%. For Finance, earnings are expected to be down -5.2% on -0.2% lower revenues. The Context for Growth Expectations Let s take a look at how consensus earnings expectations for 2016 Q2 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 quarterly earnings growth rates actuals as well as estimates. Table 3 presents the same data for revenues. www.zacks.com 11
Table 2 Earnings Growth Context www.zacks.com 12
Table 3 Revenue Growth Context www.zacks.com 13
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. Table 4 Total Quarterly earnings www.zacks.com 14
Table 5 Total Quarterly Revenues www.zacks.com 15
It may be obvious, but it s still useful to explain what we mean by total earnings. This means the sum of net income for all companies in the S&P 500. For historical periods through 2016 Q1, we have taken the total earnings (net income, 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, including the ongoing Q2 reports, 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. In plain language, what www.zacks.com 16
Table 4 tells us is that companies in the S&P 500 earned $248.1 billion in 2016 Q1 and are currently expected to earn $267.9 billion in 2016 Q2. Annual Earnings For full-year 2016, total earnings for the S&P 500 index are currently expected to be down -2.6% on 0.4% lower revenues, which would follow the -1.1% decline in the index s total earnings last year. On an ex-energy basis, 2016 earnings would be up +0.2% vs. +5.9% in 2015. Table 6 below provides a summary view for 2016 contrasted with estimates for 2017 and the actual results for 2015. As you can see, consensus expectations reflect a notable improvement in earnings growth momentum next year, with total 2017 earnings for the index expected to be up +13.3% on +4.0% higher revenues and strong margin gains. Tables 7 & 8 on the following pages provide the summary annual earnings and revenue data for the 10-year period from 2008 through 2018. Table 6 Summary Annual Earnings Picture www.zacks.com 17
Table 7 Summary Annual Earnings www.zacks.com 18
Table 8 Annual Revenues www.zacks.com 19
The charts below show current consensus earnings estimates for this year contrasted with what is expected for 2017 and 2018 and actual results for the preceding 8 years. Chart 9 Total Annual S&P 500 Earnings www.zacks.com 20
Chart 10 Total Annual S&P 500 Earnings (Excluding Energy) Chart 11 Total Annual Earnings Growth www.zacks.com 21
Chart 12 Total Annual Earnings Growth (ex-energy) The three sectors expected to be big drivers of earnings growth in 2017 and 2018 include Technology, Finance and Energy. The charts below show current earnings expectations for these sectors Chart 13 Energy Expected to Stabilize www.zacks.com 22
Chart 14 Tech Growth Expected to Ramp Up Chart 15 Finance Expected to Become the Biggest Contributor www.zacks.com 23
Index EPS and PEs The table below shows the PEs and EPS for the index. As you can see, the index is expected to earn $113.99 in EPS in 2016 on a bottom-up basis and $117.96 on a topdown basis. www.zacks.com 24
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The Margins Picture The table below shows net margin expectations for Q1 in the context of where they have been and where they are expected to go in the coming quarters. Table 16: Quarterly Net Margins The charts below show current margins expectations in a historical context. The first chart shows margins on a quarterly basis since early 2011 while the second one shows annual margins since 1997. As you can see, margins are already past cyclical highs. www.zacks.com 26
Market Cap vs. Total Earnings The charts below show the share of estimated total earnings for 2016 as well as the share of total market capitalization for each of the 16 Zacks sectors. Since the S&P 500 is a market-cap weighted index, each sector s market cap share is also its index weight. The Finance sector is about even with the Technology sector in terms of earnings contribution even though it carries a smaller weight in the index. www.zacks.com 27
% Share of Mkt Cap Consumer Discrt 5.0% Retail 9.3% Medical 13.4% Consumer Stapls 8.3% Auto/Tires/Trks 1.2% Transportation 2.0% Utilities 3.1% Business Svcs 3.3% Industrial Prod 1.9% Basic Materials 2.3% Construction 0.8% Conglomerates 3.1% Finance 15.3% Computer & Tech 22.9% Oils/Energy 6.6% Aerospace 1.7% www.zacks.com 28
Share of 2016 Income Consumer Discrt 5.4% Retail 7.6% Medical 15.4% Consumer Stapls 6.9% Auto/Tires/Trks 2.5% Transportation 2.9% Utilities 3.3% Business Svcs 2.8% Industrial Prod 1.8% Basic Materials 2.5% Construction 0.7% Conglomerates 3.0% Finance 20.9% Computer & Tech 21.4% Oils/Energy Aerospace 1.2% 1.6% Want more information about this report or about Zacks Investment Research? Contact Terry Ruffolo at 312-265-9213 or at truffolo@zacks.com Visit the Zacks Media Room at zacks.com/media-room 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. www.zacks.com 29