Earnings Season: 80% Of Companies Are Doing Fine, But Market P/E Could Drop To 14

Wall Street Gloom Is at Odds With Profit Gains

 by Thomas Black 

Vulcan Materials Co.’s (VMC) profit doubled in the fourth quarter and is forecast to expand 50 percent this year. Still, the construction-materials company’s shares have fallen 6.1 percent in three months.

Welcome to the first earnings-report cycle in 2016, where the steep oil-price drop that’s pummeling energy companies has triggered broader Wall Street pessimism and obscured decent results from companies like Vulcan. As a whole, earnings in the Standard & Poor’s 500 (SPX) (SPY) are on pace for the biggest quarterly decline since 2009. But strip out the energy-sensitive industries (XLE) and most companies are reporting profit gains.

“There’s a big disconnect between what people on the Street are saying and what the companies on the ground are seeing,” said Todd Vencil, an analyst with Sterne Agee CRT who covers building-materials companies, including Vulcan. 

The S&P 500 index has declined 5.7 percent this year through Wednesday, with investors jittery about the Federal Reserve raising interest rates, China’s slowdown and a strong dollar that’s hurting U.S. exporters. Countering that is continued strength in U.S. consumer spending, buoyed by more jobs, low interest rates, little inflation and plummeting gasoline prices.

“We think that people are under-appreciating the strength of the U.S. consumer,” (XLP) (XLY) said Michael McDonough, chief economist for Bloomberg Intelligence.

Earnings Results

Fourth-quarter earnings have declined 4.9 percent with 404 companies from the Standard & Poor’s 500 Index reporting through Wednesday, according to data compiled by Bloomberg. But take out the energy companies, and profit has risen 1.2 percent. And that figure becomes about a 5 percent gain when industrial companies and the basic-materials sector are also excluded, said Jonathan Golub, chief U.S. market strategist with RBC Capital Markets.

In other words, Golub says, 80 percent of the companies are doing fine.

“The key here is that it’s a bifurcated market, not a broken market,” Golub said. “The rest of the market doesn’t look that unhealthy.”

Phil Orlando, chief equity strategist at Federated Global Investment Management, concurs and is playing defense by increasing cash and buying bonds at the firm, which oversees $360 billion in assets. “Earnings season by and large has been fine,” Orlando said. “The black hole is energy.”

Of 10 major industry groups in the S&P 500, half have reported fourth-quarter profit declines and half have shown increases. Among the groups with gains are health care (XLV), telecom (XTL) and consumer discretionary. About 75 percent of companies have exceeded earnings estimates.

Revenue has been less robust, hurt in part by a strong dollar and weak international demand that led to sales declines at companies such as Coca-Cola Co. (KO) and International Business Machines Corp (IBM). Wal-Mart Stores Inc. (WMT) said on Thursday that foreign currency shaved $4.8 billion from fourth-quarter international sales, causing total revenue to drop 1.4 percent to $129.7 billion. Wal-Mart’s U.S. sales rose 2.4 percent to $81.5 billion. S&P 500 sales have dropped 4.4 percent in the latest quarterly reports and gained 0.3 percent when excluding energy companies.

Investors’ Reaction

The wave of pessimism in the market frustrates executives who have put up decent numbers or have predicted continued growth.

Honeywell International Inc. (HON), for example, on Jan. 29 reported a sixth straight year with annual earnings-per-share growth of 10 percent or more, but its shares still haven’t recovered to last year’s peak on Aug. 10. This year, Honeywell predicts earnings will rise 6 percent to 10 percent as strong U.S. consumption helps offset slow global growth.

“The sentiment just wants to be negative,” Chief Financial Officer Tom Szlosek said during a presentation to a Barclays Plc conference Wednesday. “But you have this consumer in the U.S. that’s better than it was five years ago. They have jobs and less debt.”

Construction-material companies like Vulcan can look forward to “multiple years of double-digit revenue growth” as home building returns to historic levels and the five-year highway funding bill that Congress approved in December spurs growth, Chief Executive Officer Tom Hill said. Vulcan and competitor Martin Marietta Materials Inc. forecast that earnings before interest, taxes, depreciation and amortization will increase 25 percent this year, and analysts estimate earnings per share will jump about 50 percent for both. 

Falling PE Ratio

Executives should brace themselves: The selloff isn’t over, says Mark Luschini, chief investment strategist at Janney Capital Management. With poor earnings and subpar economic growth, the S&P 500 Index’s price-earnings ratio, which topped 18 in December, could drop to as low as 14, he said.

 “The market is resetting prices to a lower earnings growth profile,” said Luschini, whose firm manages $65 billion of assets. “Unless the economy improves a little bit more, I don’t expect to see earnings growth increase to much more than low single digits.”

The U.S. economy is forecast to grow 2.2 percent this year, based on the median estimate of 83 economists surveyed by Bloomberg. Earnings growth this year could reach 4 percent if oil prices rebound to around $35 a barrel to shore up energy companies and interest rates rise to more than 2 percent to help financial stocks, Golub said. 

Economic indicators “don’t see the world as a great place,” Golub said. “But seeing the world coming to an end or the market going over a cliff is probably a bad bet.”

Courtesy of bloomberg.com