ANALYSIS:US firms have boosted earnings by massive cost cutting – but this will be hard to repeat, writes PROINSIAS O'MAHONY
A POSITIVE start to earnings season in the US has seen markets soar over the last fortnight, with indices hitting new 2009 highs and the tech-laden Nasdaq rising 10 days in succession. Cautious observers are warning that the earnings picture is not as exuberant as appears, however, with companies beating estimates as a result of aggressive cost-cutting measures rather than through revenue growth.
Cosmetic analysis suggests that recent equity gains are well-deserved. Bloomberg reported this week that 79 per cent of companies have beaten earnings estimates so far this season, the highest proportion since the firm began collecting the data in 1993. That’s a noticeable improvement on the first-quarter beat rate – 62 per cent – which was itself a big jump from the 55 per cent figure registered in the previous quarter. Actual earnings are surpassing estimates by an average of 10 per cent.
The season began with Goldman Sachs and JP Morgan trouncing earnings estimates. Earnings beats from Intel and IBM, amongst others, soon followed. On Tuesday, construction giant Caterpillar catalysed market gains. “Caterpillar still thinks it can fly,” enthused Forbes, while Bloomberg reported that the company “tripled earnings estimates”. However, revenues of $7.98 billion (€5.6 billion) were 41 per cent lower than the year-ago period and almost a billion lower than expected – hardly a “blow-out quarter”, as one headline read.
It was a similar story with the other big names that reported on Tuesday. Coca-Cola beat earnings but revenues were almost $400 million shy of estimates. Revenues tumbled by 24 per cent at chemical giant DuPont, which missed estimates by $150 million.
United Health revenues were $700 million lower than estimates. Southwest Airlines, Merck, Texas Instruments and copper producer Freeport-McMoran all beat estimates even as revenues declined substantially on a year-over-year basis.
Wednesday saw Starbucks shoot up after it announced better than expected profits of $151 million. Again, cost-cutting – $550 million in cuts is projected for 2009 – rather than revenue growth was the key factor. Revenues fell by 6.6 per cent amid dwindling customer traffic.
Ford cheered investors yesterday after beating expectations but McDonald’s were short of revenue estimates.
The Nasdaq has been the focus of much attention, its 10-day winning run the longest such streak since 1998. Intel triggered a global rally last week after predicting 2009 sales of $8.1-8.9 billion, well ahead of forecasts of $7.8 billion. The ever-reliable Apple blew past expectations this week while EBay beat estimates yesterday. Technology companies, however, have also struggled on the revenue front. Nokia’s revenues came in below expectations, declining by 25 per cent. Sales at Sony Ericsson suffered a massive fall of 40 per cent. Cisco announced 600-700 job layoffs. Sun Microsystems’ revenues ($2.58 billion) were well below estimates ($3.03 billion). Google, Dell and Yahoo all disappointed. Despite beating earnings estimates, Qualcomm fell in early trading on Thursday after missing revenue estimates. Even IBM, whose earnings per share of $2.32 comfortably surpassed the $2.02 estimate, came up shy on revenues.
In the financial sector, things have been just as mixed. Citigroup and Bank of America would have recorded big losses had they not sold a combined $16 billion in pre-tax assets. Morgan Stanley and Wells Fargo slipped in the wake of their results. Goldman Sachs and JP Morgan, in contrast, are now the undisputed heavyweights in the financial world, although the recent gigantic profits announced at both firms was partly the product of outsized gains on the trading floor. Despite their efforts, profits at US financials are expected to be 52 per cent lower than a year ago. Overall, just 49 per cent of companies have beaten analyst revenue estimates.
Accordingly, analysts are increasingly cautious. “Companies hit their earnings numbers largely on deflationary cost-cutting moves,” Gluskin Sheff’s David Rosenberg recently warned. Rosenberg noted that General Electric’s recent poor earnings “attracted much less media attention” than other company results, “even though it is the best proxy for US nominal GDP given the vast array of businesses the company operates”. Revenues fell by 17 per cent at GE.
Morgan Stanley analysts this week advised investors to “sell into” the global equity rally, partly because “positive earnings momentum” may “prove more transitory than the markets believe”. Dresdner analysts caution that corporations have “aggressively” cut costs but “further gains on that front may slow”. Barclays analyst Barry Knapp, meanwhile, bemoaned “low-quality earnings that are due more to cost cutting than top-line growth”.
Overall, the outlook remains shrouded in uncertainty. Last week’s admission by Tom Johnstone, head of SKF, the world’s biggest manufacturer of industrial bearings, that the outlook was “incredibly uncertain” was echoed this week by Caterpillar executives, who justified their wide profit range for 2009 by citing “a great deal of economic uncertainty”.
Even after the recent earnings beats, profits at SP 500 companies are still expected to be 33 per cent lower than last year, with a further 20 per cent decrease forecast from July through September. The earnings data, as Dresdner recently noted, “offer something for both bulls and bears”.
