Wednesday marks the unofficial start of the September quarter’s earnings season with aluminum-maker Alcoa (AA) releasing its results after the closing bell.
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Consensus estimates collected by Thomson Financial have Alcoa delivering earnings 22 cents per share on revenue of $5.84 billion. The year-over-year increase is modest and reflects the booming automotive, aerospace and other industrial markets that should enable Alcoa to report a “good” quarter. But it’s the company’s outlook that bears watching given the slowdown in the eurozone and slowing growth in China, as well as political unrest and potential Ebola-outbreak concerns.
Alcoa is only the start of what is referred to as “earnings season” for the third quarter. All in all, FactSet data points to an expected increase of 4.6% for S&P 500 companies. Keep in mind two things: First, the expected earnings growth rate back in July at the start of the quarter stood at 9%. Second, companies trounced quarterly forecasts for the June quarter amid favorable fundamentals, but also hefty buyback programs that were shrinking the number of shares outstanding, thereby boosting reporting earnings-per-share figures. Still, the average 6.4% or so year-over-year decline in outstanding shares can pop earnings per share more than 7% even if net income is flat year over year.
When breaking down expectations for the S&P companies, FactSet notes nine out of the ten sectors have lower growth rates today compared to early July. Downward revisions were biggest at the financials and energy sectors owing to a sharp drop in expected earnings for Bank of America (BAC) due to the negative impact of the company’s settlement with the Justice Department and other government entities.
Oil prices have been declining due to the two-year surplus high in the Middle East, but with slower global prospects, odds are surplus will not burn off near term. That expectation has fueled cuts in expected earnings for energy companies with some of the larger ones at Noble Energy (NBL), Noble Corporation (NC) and Williams Companies (WMB), all of which saw double-digit cuts.
Sectors slated to report the highest earnings growth rate for the quarter include telecom, materials, and health care. That bodes well for earnings reports from the likes of Verizon Communications (VZ), Comcast (CMCSA), Vulcan Materials (VMC), chemical company PPG Industries (PPG), biopharmaceutical company Gilead Sciences (GILD), and specialty pharmaceutical company Mallinckrodt PLC (MNK) as well as others.
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The one sector poised to book a decline in year-over-year earnings is consumer discretionary with the bulk of that decline due to weaker year-over-year results at PulteGroup (PHM). It’s worth noting PulteGroup’s September quarter bottom-line results are expected to be up 44% quarter-over-quarter. Only by digging deeper do we find its year-over-year earnings decline is due to a deferred tax asset valuation allowance reversal gain that benefitted earnings in the third quarter of last year.
Turning to the outlook, as mentioned, recent economic data on the eurozone and China are likely to weigh on company guidance, particularly since more than 40% of sales for the S&P companies come from outside the U.S. Also likely to soften corporate outlooks is the recent move higher in the U.S. dollar, which has gained more than 8% against the euro and 7.5% against the yen over the last three months. Safer harbors would be companies in the utilities and telecommunications sectors, which have little overseas exposure.
As I tell the graduate students I teach at the New Jersey City University School of Business, don’t ignore the cost side of the equation. Falling input prices such as corn and cotton bode well for favorable guidance from companies like Pilgrim’s Pride (PPC), Sanderson Farms (SAFM), Hanesbrands (HBI), VF Corp. (VFC) and others that consume significant quantities of these commodities when manufacturing their goods. Consumer spending could see a psychological boost from falling oil prices that will drive at-the-pump gas prices even lower in the coming weeks. Further, we could see retailers issue more upbeat-than-previously-expected guidance for the all- important holiday shopping season.
While there will be pockets of strength, looking at the stock market as a whole, the combination of the stronger dollar, weaker growth prospects in China and the Eurozone are likely to result in companies issuing more conservative top and bottom line guidance for the coming quarter or two. The logical result would be a recasting of earnings for the S&P 500 for both the current quarter and, in all likelihood, 2015 as well. If that happens, it would prompt the return of volatility into the stock market as Wall Street and investors wrap their heads around the Punnett Square of growth and valuation.
Chris Versace owns no shares of any company mentioned, but the Thematic Growth Portfolio that he manages is long Pilgrim’s Pride (PPC) shares.