Corporate earnings update – July 8th, 2012 – revenue growth now an issue

On Friday, ThomsonReuters released their latest earnings data and the “forward 4-quarter” earnings estimate for the S&P 500 rose to $110.94, about where we thought it would when we wrote about the same topic last week. (See the July 5th blog post on the history or pattern of the S&P 500 earnings estimates as we roll into each new quarter.) As of Friday’s market close the S&P 500 was trading at 12(x) those forward earnings for expected growth of 3% to 5% this quarter.

Earnings kick off this week with Alcoa (AA) on Monday, July 9th and then Wells Fargo (WFC) and JP Morgan (JPM) on Friday morning.

We posted our preview on Alcoa on Seeking Alpha’s website late last week ( No one is expecting anything positive out of Alcoa anytime soon, which is exactly why we still hold the stock. As we detail in our Seeking Alpha preview, AA today is a perfect trilogy of:

1.) Poor sentiment – analysts have been revising estimates lower and NO ONE is expecting management to say anything good about the remainder of 2012. Short interest has been growing too;

2.) Technicals still intact – AA has now put in a triple-bottom near $8.30 – $8.45 in October, 2011, December, 2011 and June, 2012.

3.) Very cheap valuation: AA is trading at a 15% discount to tangible book value of $10.61 and 5(x) cash-flow per share. On an enterprise value (EV) basis, AA is trading about 8(x) EV to cash-flow.

To say that earnings expectations for the 2nd quarter are now low or subdued is quite the understatement, but in fact there is some reality to that too.

According to ThomsonReuters, q2 ’12 earnings growth is 5.8%, but if we “ex-out” a big bump from Bank of America, as well the entire Financial sector, growth is closer to 0% or flat year-over-year. (The problem with that is that we can “ex-out” something every quarter and the actual results always look grimmer. Last quarter in q1 ’12, there was some exclusion of AAPL’s earnings, which reduced q1 ’12 earnings growth by 3%, to 5% from the actual 8.1%. Let’s take that a step further and remove any company with any kind of above-average growth, get very depressed, and build a bomb shelter to go hide in.)

What I do worry about this quarter is expected revenue growth: right now the expected revenue growth for q2 ’12 is +2%, dowm from +5% in q1 ’12. Has revenue growth slowed that much, or have analysts become too pessimistic about q2’12 ?

Inquiring minds want to know.

Off the 2009 market low, revenue growth was low single-digits, but productivity gains, debt refinancings, and SG&A control drove eps growth of 20% – 30% for the S&P 500 until last summer, when that growth started to taper off. Revenue growth did accelerate to the mid single digits in mid 2010 but now looks to revert to the 2009 level as of q2 ’12.

In the irony of ironies, the Financial sector is expected to grow earnings 53.6% in q2 ’12 while utilities are expected to have the worst y/y growth at -16%, even though financials were one of the worst performing sectors in q2 ’12, while utilities were one of the best.

Maybe even more interesting, since April 1, technology and telecom are the only two sectors that saw their expected q2 earnings growth rates revised higher over the last 13 weeks, while the financial sector has fallen from a lofty 70% on April 1, 2012 to 53.6% as of July 6th. Tech has been revised higher from 6.9% to 7.9% while telecom has seen a sharp upward revision from -11.6% on April 1 to +0.6% as of July 6th.

How are we playing the earnings season ? We are taking it one company at a time. Look for companies where the pessimism has gotten too pronounced, like a Ford (F) or some of the industrial names. Industrials as a sector underperformed in q1 ’12’s racy market but held steady in q2 ’12. Industrial earnings growth is expected at 10.2% as of July 6th, down from 10.4% as of April 1. We think the industrial / defense conglomerates like United Technologies (UTX) and Honeywell (HON) or a 3M (MMM) have a lot of bad new discounted in prices and could surprise to the upside. Don’t forget GE either. At $20 per share, you can still buy GE below where Warren Buffett bought his preferred stake.

Finally, our patience is wearing thin on Alcoa. The stock popped higher after April’s upside surprise and then stayed range-bound all quarter. The valuation is cheap, but we need to see something from management that they can control their own destiny.

Thanks for reading.

Long all of the above mentioned.


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