The following is an excerpt from this week's Earnings Trends article. To see the full article, please click here.
A Good Start to Q2 Earnings Season
The 2014 Q2 earnings season has gotten off to a relatively positive start, though the small sample of reports at this stage is heavily weighted towards the Finance sector. We will know more in the coming days as companies from outside of Finance post numbers, but it wouldn’t be wrong to say that we have made a reassuring start.
As is the case every reporting cycle, the big banks and brokers dominate the initial Finance sector reports. The handful of big money-center banks carry a lot of weight in the sector as a whole, bringing in roughly 40% of the Finance sector’s total earnings, and set the stage for what to expect from the other sub-industries.
Estimates for the big bank earnings had fallen ahead of the start of the earnings season as it became clear that weakness in the capital markets business will compound the existing mortgage banking woes. There is not much growth as earnings essentially remain flat from the year-earlier level, but results have been coming in marginally better relative to subdued expectations.
The outperformance is coming from a combination of absence of major negatives and modest improvements in core businesses. On the commercial banking side, we are seeing loan growth starting to pick up on the back of improving commercial and industrial loans and momentum in auto loans even as mortgage portfolios continue to decline and the net interest margin backdrop remains difficult. The improvement on the investment banking side is more notable – we saw that with Citi (C), J.P. Morgan (JPM) as well as Bank of America (BAC). The trading side of the business is still struggling, likely reflecting a secular decline given the changed regulatory environment.
Litigation charges have been, and remain, a recurring part of the big banks’ business model, with the issue particularly acute in the Bank of America case which came out with a surprisingly big charge in Q2 after an even bigger one last quarter. Unlike Citi and J.P. Morgan, they still haven’t come to terms with the Justice Department on what investors hope will be the last piece on the litigation front.
Looking at the Finance sector results thus far, total earnings for the 12 companies that have reported results (out of 80 total in the index or 15% of the sector’s total) are down -1.6% on -2.4% lower revenues, with 83.3% beating earnings and 50% beating revenue estimates.
The table below shows the Q2 earnings scorecard for the component (medium level) industries in the Finance sector. As you can see, the earnings season is almost over for the Major Banks industry, with almost 85% of the industry’s total market capitalization already reported Q2 results.
The table below compares the results thus far for Finance sector industries with what we saw from the same industries in the preceding quarter and the 4-quarter average.
The sector’s Q2 results have been better relative to expectations as well as what we saw in the preceding quarter. But overall earnings are essentially flat from the year-earlier level, with the absence of growth sticking out. The net interest margin and capital markets backdrop is unlikely to improve in the current period, but investors will be hoping that the improving signs on the investment banking and loans fronts will pick further and drive earnings growth.
Q2 Scorecard (as of July 16th, 2014)
Including this morning’s earnings announcements, we now have Q2 results from 44 S&P 500 members that combined account for 14% of the index’s total market capitalization. Total earnings for these 45 companies are up +5.2% from the same period last year on +2.8% higher revenues, with 68.9% beating EPS estimates and 57.8% coming out with positive revenue surprises.
The two sets of charts below compare the earnings and revenue growth rates for these 45 companies with what these same companies reported in 2014 Q1 and the 4-quarter average and the second chart compares the beat ratios for these companies.
And More Positive Surprises
Not to make too big of a deal from the results thus far, but it is nevertheless a good start to the earnings season, particularly relative to the last reporting season. Critics could justifiably argue against the value of comparing anything to Q1, given how weak that period was. We will have to wait and see how the rest of the reporting season unfolds, but some of the commentary from the likes of Intel (INTC), Johnson & Johnson (JNJ) and CSX Corp (CSX) in recent days represents an improvement over what we have been hearing in past.
- The 2014 Q2 earnings season has gotten underway, with results from 45 S&P 500 members already. Total earnings for these companies are up +5.2% on +2.8% higher revenues, with 68.9% beating EPS estimates and 57.8% coming ahead of revenue estimates. This is better performance than we have saw from the same group of companies in Q1.
- The Finance sector is heavily represented in the results thus far. With results from 38.1% of the sector’s total market capitalization already, earnings are down -1.6% on -2.4% lower revenues. Excluding Bank of America, the sector’s total earnings would be flat from the same period last year.
- Results from the Technology sector are off to a good start as well, with total earnings for 14.8% of the sector’s total market capitalization that have reported up +23.7% on +7.4% higher revenues. Strong gains at Intel (INTC) and Micron Technology (MU) are driving all of the year-over-year growth for the sector. Excluding these two companies, total Tech sector growth at this stage drops -2.2%.
- The composite Q2 picture for the S&P 500, combining the actual results from the 45 companies with estimates for the 455 still to come, is for earnings to down +4.4% from the same period last year, on +1.8% higher revenues and 28 basis points in lower margins. Sequentially, total earnings for the S&P 500 are expected to be up +5.3%, with the overall level of total earnings for the index expected to reach a new all-time quarterly record.
- Three sectors – Utilities, Construction and Business Services – are expected to show double-digit growth rates in Q2. The Finance sector was earlier expected to see total earnings decline in Q2, but the picture has improved following the big bank results, with the sector now expected to show growth of +2.3% after the -7.1% decline in Q1.
- Total earnings for the Utilities sector, the strongest price performer in the S&P 500 year to date, are expected to be up +10.3% after the +18.0% gain in Q1. The sector was a beneficiary of the frigid weather in Q1, the Q2 growth pace is a bit misleading as it primarily reflects easy comparisons for Verizon (VZ), which we place in the sector.
- Total earnings for the Technology sector are expected to be up +6.8% from the period last year on +5.0% higher revenues. This would follow +3.3% earnings growth for the sector on +2.7% higher revenues in Q1.
- Beyond Q2, earnings growth for the S&P 500 is expected to accelerate to +5.6% in Q3 and +9.1% in Q4, with growth in the second half of the year ramping up to +7.4% from the first half’s +2.7% pace. Total earnings are expected to be up +7.1% in 2014 and +11.7% in 2015.
To see the Full Earnings Trends report, please click here.