Q2 Earnings Preview : 1Q13 earnings season wrapped up at the end of June, with mainly the Retailers and a handful of Tech companies having reported since our last earnings update. The retailers reported mixed results, with many citing colder than expected weather negatively impacting spending. Softness in Europe and Asia were the most-cited headwinds by companies during the course of the quarter. S&P 500 1Q EPS came in at $26.74—more than 3% better than consensus expectations, and also exceeding our forecast of $26.25 via a report today from Savita Subramanian, equity and quant strategist at BAML.
Analysts had slashed estimates going into reporting, setting a low bar to beat. All sectors except Materials and Staples saw aggregate earnings come in better than expected, with the largest beat at Financials (Chart 2). Sales, on the other hand, came in 1% worse than expected, with all sectors except Financials and Discretionary missing on the top-line.
Overall, 55% of companies beat on EPS, 44% beat on sales, and 30% beat on both. This was above the long-term average for EPS beats (53%), but below the long-term average for the proportion of companies beating on sales (58%) or both (36%). It was also worse than the prior quarter in terms of EPS and sales surprises.
Energy and Consumer Discretionary had the most top and bottom line beats in 1Q, while Materials had the fewest. In fact, Monsanto was the only company in the Materials sector to beat on both metrics.
Surprises rewarded less than history
Companies that beat on EPS and sales outperformed the S&P 500 by 1.0ppt in the five days following reporting, while those that missed on both underperformed by 1.6ppt. The magnitude of outperformance and underperformance was less than history, as beats have historically outperformed by 2.0ppt and misses have underperformed by 2.5ppt. Measured from the start of reporting season in early April, beats outperformed by 1.4ppt and misses underperformed by a greater 4.0ppt. By sector, Tech companies were rewarded most for beats, while Utilities companies were punished most for misses.
Q2 Earnings Preview
Bottom-up consensus expectations for 2Q13 EPS have been declining for over a year, and have still seen further cuts in the weeks leading up to this earnings season. Analysts currently expect 2Q EPS of $26.64, now slightly below our forecast of $26.75. This represents earnings growth of 1.4% YoY, or -1.6% ex. Financials. Only the Consumer sectors, Financials, and Telecom are expected to see YoY earnings growth this quarter, while Energy and Utilities earnings are
forecast to come in flat and the remaining sectors are slated to post a decline.
Sales are expected to grow 1.5% (1.3% ex. Financials), or 3.2% ex. Financials and Energy. This is a slight improvement from last quarter’s growth of 1.3% (1.2% ex. Fins.), but remains tepid. The recent improvement in the sales forecast revision ratio (more on this below) is one encouraging sign, suggesting that the improving sales trend could be sustainable, and could even accelerate as the year progresses. We expect global growth to reaccelerate in the 2H of this year.
Early reporters suggest fewer positive surprises than in 1Q
Thus far, 22 companies (primarily from the Consumer and Tech sectors) have reported 2Q13 earnings. While not necessarily a representative sample of the S&P 500 due to sector exposure, these “early reporters” (companies with May quarterend) can give an early read on EPS & sales surprises. So far, 50% have beaten on EPS, 45% have beaten on sales, and 23% have beaten on both—a lower proportion of beats than what we saw last quarter at this time when nearly 60% had beaten on EPS, 50% had beaten on sales, and 27% had beaten on both. Results have been mixed, with the top- and bottom-line beat by Lennar highlighting the ongoing improvement in US housing while a rare miss by Oracle on software licenses suggests continued weakness in Asia. Coupled with the recent deterioration in the management guidance ratio as well as the low proportion of companies issuing guidance in June, we think that positive surprises could be fewer in number this quarter.
Analyst optimism pauses, though sales outlook less negative
After growing increasingly more positive in the previous few months, analyst optimism paused in June. The three-month earnings revision ratio (ERR) ticked down following five months of improvement, and at 1.0 indicates that analysts are revising up as many estimates as they are revising down. This is above the long term average. Domestically-oriented stocks continued to see more positive than negative revisions to earnings, while the reverse remains true for multinationals.
The three-month sales forecast revision ratio improved slightly in June for the fourth consecutive month, but at 0.7 remains below its long-term average of 1.0. The one month ratio ticked up to 0.8 from 0.5, indicating that analysts continue to make more downgrades than upgrades to sales forecasts, but are growing less negative. Given that sales growth has remained anemic, a sustained improvement in this revision ratio amid the upcoming Q2 earnings preview season would be very positive, in our view.
…but management kept quiet in June
Management guidance trends also weakened in June following two months of improvement. The three-month management guidance ratio dipped to 0.4, indicating that management continues to guide below consensus more than twice as much as above. The more volatile one-month guidance ratio actually plunged to its lowest level on record, although we note that this was based on a very small set of companies –the fewest ever instances of guidance for the month of June. A lack of guidance is generally worrisome, but we observed a similar situation the last two quarters, where analysts slashed estimates ahead of reporting season and management went mum, but earnings ultimately beat by 3% each quarter and the market rallied. Given that guidance and revisions had both been improving in the prior few months, we will be following companies’ commentary closely in the coming weeks to discern whether June data represents merely a pause in the cycle or a reversal in earnings and guidance trends.
