Since the first-quarter earnings season kicked off in mid-April, an interesting irony has begun to take shape: as the rate of growth in quarterly earnings has increased, this has been accompanied by a decline in the rate at which companies are beating analysts’ earnings forecasts when they report their results. In early March, analysts were expecting companies in the S&P 500 index to report earnings growth of only 2.7%; today, that figure is 7.9%. But as that earnings growth has improved, fewer companies are beating estimates: as of last week, that figure was 67%, down from the 80%-plus rate seen only two weeks ago.

Digging into sectoral results quickly shows why the beat rate is falling. Many Energy and Utilities companies, which tend to report later in the earnings season, have had a difficult quarter. Since January of this year, analysts have cut their estimated earnings growth rate for companies in the Energy group from 7.5% to the current 1.3%, while the forecast magnitude of losses by companies in the Utilities sector widened, as analysts predicted losses of 8.1% compared to 6.8% previously. Still, more than half of the companies in these sectors that reported results last week failed to live up to analysts’ lowered expectations. In contrast, groups that reported earlier in the period – the Financials and Information Technology companies in the S&P 500 – beat estimates at a far greater rate. Additionally, the larger surprises reported by companies in these sectors has continued to drive the growth rate higher. In contrast, Energy and Utilities are the only sectors that have had aggregate earnings come in at lower levels than estimates suggested they would.

In a quarter during which so many companies have defied the original gloomy expectations of analysts and reported solid results, why are these sectors disappointing? One reason is natural gas prices, which are stuck in the doldrums. In recent years, energy companies have continued to discover massive new natural gas deposits, even when they were actually searching for crude oil deposits. The ensuing rush to develop these discoveries drove supplies sharply higher, causing a corresponding plunge in its price. (see Exhibit 2) Low prices have hurt exploration and production companies as well as gas marketing businesses. Several of these companies specifically mentioned low natural gas prices as a reason for their disappointing earnings results.

Of the 500 companies in the S&P 500 index, 76 belong to the Energy and Utilities sectors – in other words, they make up 15% of the index. Together, however, they have managed to post three of the index’s five largest negative earnings surprises and four of the five largest negative revenue surprises. And while natural gas prices are certainly not the only factor involved in this poor performance, it isn’t surprising that the commodity price weighed heavily on the minds of managers discussing their results last week.

One of the largest negative surprises of the earnings season last week came from utility company NRG Energy Inc (NRG.N), which reported a loss of 92 cents a share, much larger than the 13 cents a share analysts had forecast, adding up to $181 million in unanticipated losses. “We have had to attack relentlessly against the headwinds of constantly lower commodity prices in order to produce reasonable financial results … for four years,” NRG CEO David Crane told the earnings conference call audience. Still, he remained optimistic that the cycle may be about to turn. “It feels to me like we have reached, during this quarter, an inflection point in the commodity price down cycles that have gripped the wholesale portion of our business since the great recession.”

Even without taking into consideration its corporate governance controversies, Chesapeake Energy (CHK.N) had a difficult week last week. The company reported first quarter earnings of 18 cents a share, missing the consensus estimate of 29 cents by 38%. Again, the blame fell on low natural gas prices: more than 80% of Chesapeake’s production is natural gas. Nonetheless, Chespeake’s CFO, Nick Dell’Osso, shared NRG’s optimism, commenting that the company hasn’t hedged its gas prices to protect itself from further price declines. Chesapeake, he added, is “hopeful some of the worst gas prices may be behind us.”

If the companies that find and sell natural gas are suffering from low prices, is there anyone who benefits from rock-bottom gas prices? Given the current boom in production, companies that sell services to natural gas producers are seeing opportunities to boost revenues and earnings; Quanta Services Inc. (PWR.N) is one of these. This construction and engineering company reported first-quarter earnings of 22 cents per share, well above analysts of 16 cents a share. CEO Jim O’Neil reported a 103% increase in revenues from its natural gas transmission and pipeline business. “Demand for gathering system pipeline infrastructure within the shales is strong,” O’Neil said, referring to the Marcellus, Eagle Ford and Bakken shale systems. “We remain encouraged by the opportunities we continue to see for our natural gas and pipeline segment.”

There are only a handful of Energy and Utilities companies in the S&P 500 index that have yet to report their first-quarter results, so the cloud that low natural gas prices is casting over S&P 500 corporate profits is likely to drift away over the horizon in the coming days. Going forward, investors and analysts alike will be keeping an eye on whether other companies – such as those who rely on natural gas as a raw material – will see the low commodity prices as a favorable element, and report higher earnings as a result.

 
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