zondag 9 juli 2017

Q2 Earnings Preview: "After Strong Q1 Guidance, Watch Out For Weakness In Q2"

2Q17 earnings season kicks off next Friday with four banks (Citi, JPM, Wells And PNC) reporting results, accounting for roughly 5% of the S&P 500 by market cap. 89% of the S&P500 is expected to report earnings by August 4th. And while most analysts expects a beat vs. consensus (+7% EPS) in 2Q, BofA warns that analysts’ forecasts continue to look overly optimistic for the 2H, particularly in 4Q...


After an “as good as it gets” 1Q17 (EPS growth hit a five-year high, sales growth was the best in over two years, and beats hit a 13-year high) largely thanks to a rebound in energy profits, decelerating trends are expected in 2Q, when as Goldman is quick to note, consensus expects S&P 500 EPS year/year growth of 7% in 2Q - driven once again mostly by a forecast 370% rebound in Energy EPS - roughly half the 14% EPS growth in 1Q. Excluding Energy, EPS is expected to grow by 4%, led by Info Tech (+10%) and Financials (+6%). Sales growth is expected to be led by Energy (+26%) and Information Technology (+12%). Two sectors, Materials and Telecom Services, are forecast to experience declines in revenues. Only three sectors are expected to expand margins during the second quarter (Energy, Telecom Services, and Materials).
Goldman further adds that S&P 500 margins of 9.5% are expected to remain flat vs. 2Q 2016, with just three sectors forecast to expand margins. As so often happens coming into the reporting quarter, bottom-up Q2 consensus has declined from $33 one year ago to roughly $31.50, however this is actually an improvement from recent history. As BofA notes, "analysts didn’t take a knife to estimates as usual: consensus 2Q EPS has fallen just 2% over the last three months to $31.46, less than the typical pre-earnings season cut of 3%-4% and the smallest downward revision in three years." Although S&P 500 EPS estimates excluding Energy were revised lower between January and May, they have been roughly unchanged since then, following stronger-than-expected 1Q earnings results...


As a result, BofA forecasts Q2 S&P500 non-GAAP EPS of $32.00, implying +8% YoY growth, a 2% beat vs. consensus but below the post-crisis average beat of 4%. Consensus, while less optimistic than BofA, expects earnings growth of +6.7% YoY and sales growth of +4.6% YoY, both decelerations from the multi-year records set in 1Q17. All sectors except Utilities and Discretionary are expected to see positive YoY earnings growth, with weakness in Discretionary earnings chiefly attributable to Autos. Aside from Telecom, where 1Q earnings were weak in part due to promotional activity/rolling out of unlimited data plans, 2Q earnings are expected to accelerate in Industrials vs. slow or flat-line across the other sectors. Analysts expect sales growth of +5% YoY (vs. +7% in 1Q), and constant-currency sales growth for the S&P ex. Fins. & Energy of +5% YoY (vs. +6% in 1Q)...


With oil tumbling throughout most of Q2, it is no surprise that energy has seen the biggest downward revision to estimates over the past one and three months (Chart 3). While most other sectors have also seen negative revisions, industrials is the one sector which has seen positive revisions over both the last one and three months...


Looking at Energy earnings, Goldman confirms that the substantial decline in oil prices in June represents a downside risk to Energy EPS. That said, relative to 2Q 2016, average Brent oil prices were 8% higher in 2Q 2017, which will likely support a rebound in Energy EPS. "However, oil prices rapidly declined from $56 in April to $45 in June. Energy EPS is therefore at risk from lower oil prices (lower revenues) and higher rig counts (higher costs). Consensus EPS estimates for Energy have already been revised down by 15% since the start of 2Q. Additional negative revisions to full-year Energy profits would pose a risk to overall S&P 500 EPS growth, given 25% of 2017 EPS growth is expected to come from Energy alone."
Another potential risk is the tight labor market which Goldman believes remains a potential headwind to Consumer Discretionary and S&P 500 earnings. The US economy added 222,000 jobs during the month of June and average hourly earnings grew 2.5% year/year. Many wage measures have shown signs of deceleration in recent months and our GS Wage Tracker stands at 2.4% (vs. 2.7% in 2Q 2016). However, given that the US economy is at full employment, our US Economics team expects wages will continue to rise: We previously estimated that a 100 bp acceleration in wage inflation would reduce annual S&P 500 EPS by roughly 1%. Labor-intensive sectors such as Consumer Discretionary are most at risk from rising wages. The combination of wage pressures and weakness in Autos and Retailing will weigh on Consumer Discretionary earnings, which are expected to fall by 3% in 2Q, the most of any sector There is potential for upside surprises, most notably coming from the dollar.
# As BofA writes "continued weakness in the US dollar, down 5% in the 2Q, is a positive, as are corporate commentary, management guidance and revision trends." Goldman agrees and adds that in addition to fading USD strength, higher interest rates should also support 2Q EPS growth. Looking specifically at banks, Goldman writes that "while some banks have noted that subdued trading activity during 2Q may weigh on earnings, a higher rate environment and increased buybacks and dividends following CCAR results will likely support Financials returns in 2H 2017. Every 100 bp increase in 10- year bond yields adds roughly $0.50 to annual S&P 500 EPS, all else equal." 
Additionally, as Goldman notes, "better-than-expected margins for large-cap Info Tech firms represent an upside risk to 2Q EPS. Consensus expects Info Tech margins will decline by 31 bp in 2Q. Mathematically, significant Info Tech net margin expansion appears unlikely following GOOGL and FB's decisions in 1Q 2017 to change their accounting to include stock-based compensation in their adjusted earnings. The policy shift will act as a one-time headwind to the calculation of margins in 2017. However, Info Tech margins beat consensus forecasts in 1Q and we estimate full-year 2017 Info Tech margins will be stable at 19.9%." The biggest risk, however, may be a slump in early euphoria now that the Trump fiscal agenda appears hopelessly stuck. As Bank of America summarizes, "after strong 1Q guidance, watch out for weakness in 2Q" and notes that guidance trends ahead of earnings have remained strong: the three-month ratio of above vs. below consensus guidance fell slightly in June after three months of improvement, but remains at its highest levels since late 2014. And the one-month ratio was above its June average."
However, since then optimism has fizzled, and while those corporates issuing guidance generally been positive, instances of guidance have grown sparse: BofA counts just 18 instances 2Q or full-year earnings guidance by S&P 500 companies last month, the lowest ever for the month of June, and adds that "after record optimism by corporates in 4Q and 1Q following the election, BofA suspects corporates could temper their tone in 2Q given growing uncertainty around the timing and magnitude of tax reform/stimulus and the increase in negative economic data surprises"...


# The bottom line: while a healthy Q2 is largely in the cards, the biggest question is what happens in Q3 and the second half in general, or as BofA puts it: "While we expect a beat vs. consensus in 2Q, analysts’ forecasts continue to look overly optimistic for the 2H, particularly in 4Q"....

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