Earnings Roundup: Earnings Beats May Not Be as Impressive as They First Appear
Industrials companies beat earnings expectations, but many post disappointing revenues. Is this an anomaly or a warning sign?
With each week that has passed since the beginning of the second-quarter earnings season, the growth rate in reported profitability has crept higher. Last week, the blended earnings growth rate hit 7.2%; even once Bank of America’s (BAC.N) big jump in profitability is removed from the equation, that still translates to a 1.9% gain in corporate profits for the just-completed quarter compared to the same period of 2011. (Bank of America’s gain was attributable to a one-time charge in the year-earlier period relating to the settlement of mortgage lending cases.) Given that analysts had been gloomily warning that earnings growth would be flat after dismissing Bank of America’s big advance, this is an impressive feat. Moreover, as of the end of last week, companies in the S&P 500 have been beating earnings estimates at a higher rate than in a typical quarter, with 71% of those reporting last week posting results above levels that analysts had projected.
These second-quarter reports may not be as rosy as these figures make them seem, however. That’s because underneath the headline-grabbing growth in profitability, it’s clear that companies aren’t doing nearly as good a job when it comes to beating analysts’ expectations on the revenue front. Last week’s crop of second-quarter earnings reports from industrial companies – one of the strongest sectors in the market, of late – reinforced that trend, with ten of the 12 S&P 500 Industrials companies that announced results last week posting better-than-expected earnings but only three saying that their revenue came in ahead of expectations.
Exhibit 1. Industrials Companies – Revenue and Earnings Surprises – July 30 through August 3
Source: Thomson ONE.
At the beginning of earnings season, analysts were predicting that industrials companies – as a group – would generate 6.4% growth in revenues, putting them third among the ten sectors in the index. So far, however, only 26% of industrials companies have announced revenues that were higher than analysts’ forecasts, and that revenue growth rate was only 5.5% as of the end of last week. To produce higher earnings on lower-than-anticipated revenues requires companies to boost their margins, and indeed, industrials in the S&P 500 have seen their net margin climb from 8.6% to 9%.
Masco Corp. (MAS.N), a manufacturer of home building supplies, is seeing its stock price fall today as the broader market rises, after it fell short on both earnings and revenue forecasts last week. True, the company doubled its year-earlier profit, posting earnings of 10 cents a share, but analysts were expecting it to do better still, while the company grappled with limited home remodeling activity and a still-sluggish new home market. The second half of 2012 appears more challenging, CEO Tim Wadhams warned conference call participants. At the other end of the spectrum, Quanta Services Inc. (PWR.N) posted positive surprises on both revenue and profits, announcing a 50% jump in revenues and a 107% increase in revenues thanks to high growth in natural gas drilling activity. The only factor limiting future growth, suggested CEO Jim O’Neil during the conference call, is the amount of investment required to build infrastructure, such as the pipelines needed to get output from the Bakken, Eagle Ford and Marcellus shales to processing facilities.
While Quanta and others in that part of the industrials universe may be benefitting from the drilling boom in the energy industry, it is the slowing global economy that is weighing on others. Heavy truck and engine manufacturer Cummins Inc. (CMI.N) posted results that were typical of industrials: a positive surprise, and a growth in earnings, accompanied by a negative surprise on the revenue front, as sales declined 4.1%. Cost controls helped the company eke out the higher profits, but CEO Tom Linebarger warned the conference call that weakness in international markets – especially in Brazil and China, together with a slowdown in U.S. orders, mean that revenues will be flat for 2012 as a whole. Revenues from China fell 25%, while international revenues dropped 16% overall, Linebarger said.
Results like this from Cummins, together with the broad trend that is taking shape, serve as a reminder to investors to look past the headline number – the earnings-per-share figure that often dominates discussions during earnings season – and focus as much on the source of those earnings as they do on the figure itself. To the extent that companies aren’t able to support earnings growth via higher revenues, companies will have to rely increasingly on boosting efficiency or cutting costs – or run the risk of disappointing investors on the earnings front as well as on revenues in the future. The trend taking shape in corporate revenues serves as a reminder of a growing source of risk to corporate earnings as 2012 moves forward.