Thursday, April 18, 2013
This morning’s economic and earnings data is reassuring enough to calm some of the growing concerns that have been roiling the markets this week. The in-line Jobless Claims numbers indicate that the labor market isn’t in a downtrend after all and positive earnings surprises from the likes of Verizon (VZ), Pepsi (PEP) and Morgan Stanley (MS) show that excessive pessimism on the earnings front may be without a basis as well. Bottom line, things may not be great, but they aren’t awful either.
The Earnings scorecard as of this morning shows Q1 reports from 81 S&P 500 companies or 16.2% of the index’s total membership that account for 23% of total market cap. Total earnings for these 81 companies are up +2.3% from the same period last year, with 69.1% beating earnings expectations. Revenues are up +3.7%, with only 32.1% of the companies coming ahead of top-line expectations.
The inability to beat revenue expectations is emerging as the key trend thus far, as the 32.1% revenue ‘beat ratio’ than 61.7% ‘beat ratio’ for the same group of 81 companies in the preceding quarter and the four-quarter average of 50.5%. The composite growth rate for the first quarter, where we combine the results of the 81 companies that are out with the 419 still to come, is for a drop of -1.5% in total earnings on flat revenues.
Attention now shifts to the Technology sector, with earnings reports from Google (GOOG), IBM (IBM), and Microsoft (MSFT) after the close today. The Tech sector is a drag on aggregate Q1 growth for the S&P 500 as a whole, with total earnings for the sector expected to decline -7.9% from the same period last year. The revenue picture isn't that bad, with total sector revenues expected to be up +2.8% in Q1. And this spotlights the margin problem for a host of industry players, including Google and Apple (AAPL). Net margins for the sector in Q1 are expected to be down more than 200 basis points from the same period last year and essentially flat from the preceding quarter.
The market may be willing to cut the Tech companies some slack for a weak showing this reporting season. But a lot will depend on how they guide towards the coming quarters, as expectations for the coming quarters, particularly the second half of the year, are for a resumption of strong growth in the Tech sector. Current consensus expectations are for total Tech sector earnings to increase by +8% in the second half of the year after declining by -5% in the first half. The second half recovery is then expected to carry into 2014, resulting in total earnings growth for the sector of +13.3%.
A big part of these second-half 2013 and full-year 2014 earnings recovery hopes rest on margin expansion. But the sector’s margins peaked in 2012 Q3 and have yet to get back to those levels. On an annual basis, the sector's net margins have been essentially flat since 2011, but are expected to make strong gains later this year and next year after contracting in the first half of 2013.
And that’s the key question in the Tech space this earnings season – can the sector get back to an expanding margins trend line? Hard to envision where the margin expansion is going to come from, but that’s what current prices reflect.
Director of Research