Many Earnings Trackers Say They’re Upbeat
Disappointing earnings projections from a number of major companies are raising fears that second-quarter results will be a collective disaster.
But some Wall Street veterans say investors may be placing too much importance on these earnings “pre-announcements” of recent weeks.
Bad news always surfaces quickly, experts note, while companies with good news have no reason to preempt themselves. Though it’s unquestionably tough to make a buck in this struggling economy, many analysts still expect to see significant profit improvement this quarter.
That is extremely important, because the only thing holding stock prices up is a belief that earnings (and thus dividends) are indeed on the mend.
The last two weeks have seen warnings of lower earnings from such disparate companies as chemical leader Monsanto, software firm Lotus Development, drug giant Upjohn and engineering firm Dames & Moore. Their stocks have plunged accordingly.
In most cases, the bad news is blamed on the slow economy. Yet experts note that economic signals for much of April and May were relatively strong. (That’s two-thirds of the second quarter.) Only recently has the economy begun to appear weak again.
Ben Zacks, whose Zacks Investment Research in Chicago tracks corporate earnings, believes that many of the disappointments telegraphed so far have to do with company-specific problems. He still expects the bulk of second-quarter reports due in July to show decent gains over a year ago.
“The things that created better-than-expected earnings in the first quarter haven’t gone away,” Zacks argues. Among them, he cites deep corporate cost-cutting, lower interest rates (which reduce borrowing expenses), and for many firms, gradually improving sales.
For companies that export, the decline in the dollar this quarter also will help, because sales in foreign currencies will translate into more dollars when brought back home. The dollar is down 7% against the German mark since March, for example.
Overall, Zacks expects earnings of the Standard & Poor’s 500 list of blue-chip companies to be up 18% this quarter versus a year ago. In the first quarter S&P; earnings rose 7%.
But Melissa Brown, an earnings tracker at Prudential Securities in New York, says earnings for many companies will look much better only because results a year ago were depressed by major restructuring write-offs.
Judged solely on their earnings from operations, Brown expects a 4% rise in S&P; 500 results this quarter--not much, but at least it’s in the right direction.
Of course, the aggregate numbers don’t mean a lot in the short term. Most investors just care how their individual companies will perform. If an earnings bomb is going to blow 30% off a stock’s price, many investors would naturally prefer to dump the stock now, and consider buying it back after the firestorm subsides.
How can you tell if your companies are potential earnings stars, or if they’re accidents waiting to happen? Some tips:
* Were first-quarter results better than expected? History suggests that an initial quarterly earnings surprise--good or bad--is likely to be followed by a similar such surprise the next quarter. That’s especially true of positive surprises, because once a company’s business turns, it rarely peters out in a mere three months.
For that reason, Zacks believes that such industrial giants as Ford Motor and IBM, which posted surprisingly good first-quarter numbers, also will look very good this quarter. Banks too should show excellent gains, thanks to continued low interest rates, Zacks says.
An exception to the trend might be certain retail businesses. John Lonski, economist at Moody’s Investors Service in New York, notes that “annualized retail sales growth has collapsed from the first quarter’s 11.6% to an expected 3% for the second quarter,” as consumers have remained cautious spenders.
* Has the company done a good job of cutting costs? Many companies will report better profits for the second quarter not because of substantially higher sales, but because expenses have been pared to the bone through layoffs and consolidation of facilities.
Furon Co., a Laguna Niguel-based maker of plastic and rubber parts for industry, expects second-quarter results to be “significantly” above the 2 cents a share earned a year ago. But the improvement in Furon’s profit margins is “not the result of the general macroeconomic environment, but because of our own cost reductions,” says Chief Financial Officer Monty Houdeshell.
The point is, investors shouldn’t underestimate the earnings leverage some businesses will enjoy from even a slight uptick in demand. “I think the market will be surprised by how quickly the earnings of industrial firms can accelerate,” says Robert W. Gay, earnings analyst at DLJ Securities in New York.
* Does the company have any pricing flexibility? In this economy, most don’t. It’s too tough to raise prices because a competitor is always there to undercut you and take the business.
But like anything, there are degrees of difficulty here. In the airline and personal-computer businesses, price wars are raging out of control because competition is so heated. So profits in those industries will be devastated in the near term.
Ivan Png, associate professor of management at UCLA and a specialist on pricing, notes that “In any industry with excess capacity, somebody has to leave. But nobody wants to leave, so they have a price war to force someone out. It’s not very much fun to be a shareholder in these companies.”
Still, some businesses have enjoyed at least somewhat better pricing as the economy has improved. “Generally, pricing is a little easier than it was 12 to 18 months ago, though it’s still not great,” says Furon’s Houdeshell.
In the food business, meanwhile, many companies that were able to raise prices with abandon in the 1980s--when consumers felt rich--are living in a much different world.
Analyst Nomi Ghez at Goldman, Sachs & Co. notes that H. J. Heinz is suffering from cutthroat competition in the frozen-food business. For Borden Inc., the culprit is milk price wars; at Ralston-Purina, little growth in the pet food business means no pricing flexibility.
“Many food companies will have a lackluster quarter,” Ghez says. The exception: The cereal industry, where strong sales growth has allowed for price hikes.
* Is the company actively tapping new markets? K Swiss Inc., the Pacoima-based athletic shoe maker, has built a loyal customer base in the United States with solidly built shoes that endure in popularity.
But the company’s greatest potential lies in overseas markets, says CEO Steven Nichols. While U.S. sales rose 15% last year, overseas sales jumped 57% and now account for 30% of K Swiss’ total. That growth helped push first-quarter earnings up 21%.
K Swiss’ avoidance of shoe fads helps it in two ways: Its traditional high-quality image is easily transplanted to new markets; and costs stay down because the company isn’t forever tooling up for new lines.
Where Earnings Look Good
DLJ Securities analyst Robert Gay has compiled a list of companies exhibiting what he calls “good-quality earnings momentum”--meaning the companies’ rising profits stem from improving operations rather than financial tricks. A look at some of the stocks on Gay’s list, and their characteristics:
Sales 52-week Fri. Margins growth Stock high/low price rising rising Anthony Industries 14 3/4-8 1/8 10 5/8 * * Armor All Prods.* 16 5/8-9 1/4 15 7/8 * * Bank of Boston 25 1/4-7 1/8 24 1/8 * * Birmingham Steel 31 1/4-13 1/2 25 1/4 * * Charming Shoppes* 33 1/4-18 3/8 27 7/8 * * Corning Inc. 43 1/8-28 3/4 36 5/8 * * Eaton Corp. 83 1/4-54 1/2 78 1/4 * * Goodyear Tire 76 1/8-31 7/8 67 1/2 * * Hercules 55 1/8-38 3/8 52 1/4 * * Pratt & Lambert** 17 3/8-13 7/8 15 7/8 * * Pulitzer Pub.* 32 1/4-18 28 3/4 * Ryland Group 28-16 7/8 22 1/8 * Stanley Works 48 1/8-36 40 1/4 * * Staples Inc.* 35 3/4-16 28 3/4 * Wendy’s Intl. 13 3/8-8 1/8 10 7/8 * *
Positive earnings Stock surprise Anthony Industries Armor All Prods.* * Bank of Boston Birmingham Steel * Charming Shoppes* * Corning Inc. Eaton Corp. * Goodyear Tire * Hercules Pratt & Lambert** * Pulitzer Pub.* Ryland Group Stanley Works * Staples Inc.* Wendy’s Intl. *
Source: DLJ Securities * NASDAQ issue; ** Amex issue; all others NYSE
