Wall St. Worried Over Pace of Profit Warnings

By JOSH FRIEDMAN

July 9, 2001 12 AM PT

TIMES STAFF WRITER

With second-quarter earnings season getting underway this week, it’s looking like a rough summer for corporate profits--and for investors.

The stock market has already been rocked in recent sessions by profit warnings not only from technology leaders such as EMC and Advanced Micro Devices, but also from consumer firms such as Federated Department Stores and Longs Drug Stores.

Fears that analysts haven’t cut second-quarter estimates enough to reflect the weak economy helped push the Dow Jones industrial average down 2.2% on Friday to 10,252.68, its lowest since April 17.

“The worries have spread,” said Robert Stovall, market strategist at Prudential Securities in New York. After the spring rally in stocks, “The good times are over for a while,” Stovall said.

In the U.S., 721 companies have issued profit warnings, or “negative pre-announcements,” for the second quarter, said Joe Cooper, research analyst at earnings tracker First Call/Thomson Financial in Boston. That is down from the 808 warnings issued at the same point in the first quarter, but up sharply from the 217 warnings issued at this point a year ago.

Though the picture would seem brighter than in the first quarter, the scale of second-quarter pre-announcements has become increasingly troubling, Cooper said.

Last week, several firms said earnings will be well shy of analysts’ expectations, which already have been cut substantially. Federated, for instance, said its per-share earnings will be more than 30% below the consensus estimate.

By comparison, the magnitude of many earlier pre-announcements was more modest, Cooper said.

In the tech sector, warnings from such prominent names as data storage leader EMC and personal computer chip maker AMD have further rattled nerves, Cooper said.

“There has been a tug of war, with companies like Dell Computer and Intel saying [earlier in the quarter] they weren’t seeing too much of a slowdown,” he said. “But then AMD comes along and says, ‘Whoa, nobody’s placing any orders.’ And EMC, which is supposed to be a gorilla taking everybody else’s market share, says capital expenditures just aren’t what everyone thought.”

Analysts and investors will be watching early-season profit reports this week to see just how much they may have overestimated second-quarter demand. On Wednesday, Yahoo and Motorola are expected to report earnings; on Thursday, AMD and General Electric are tentatively scheduled to report.

British telecom giant Marconi’s warning last week added to fears of a drawn-out global economic slowdown, possibly even a recession. Analysts further reduced earnings estimates last week for other global telecom companies, including Alcatel and Nokia.

Cooper noted that many U.S. companies suddenly are citing sluggish European or Asian sales. BMC Software shares, for example, were clocked Friday after the company said European customers were reining in purchases.

Meanwhile, Federated’s warning last week shook U.S. investors, Cooper said, because “the consumer is all that’s been keeping us out of a recession. Now, who knows how long that will hold up?”

Companies ranging from wine maker Robert Mondavi to casino operator Harrah’s Entertainment to airline America West Holdings blamed the economic slowdown in profit warnings issued late last week.

The pace and scope of warnings have caused more analysts to give up hope for a profit recovery by year’s end and instead look to sometime in 2002.

“Even if there is no recession, the rate of recovery is going to be much slower than people thought,” Cooper said.

For companies in the blue-chip Standard & Poor’s 500 index, analysts now expect an overall 17.6% drop in second-quarter operating earnings from a year earlier and a 6.7% drop in the third quarter. But the consensus still is for a 4.8% rebound in the fourth quarter.

Cooper believes the second-half numbers are too rosy. He noted that analysts tend to be behind the curve in cutting estimates in bad times and in raising them in good times.

S&P; 500 earnings in the third quarter probably will be ratcheted down to a decline on par with the second quarter, Cooper said. For the fourth quarter the “best case is for flat earnings,” he said, thanks in part to easy comparisons to the fourth quarter of 2000.

Wall Street optimists had been hoping for a “V”-shaped economic recovery, Stovall said, “but then it turned into a ‘U’ and now it looks more like an ‘L,’ at least for a quarter or two.”

For the stock market, falling expectations for the economy and profits come at a bad time, seasonally. Since 1971, July through September has on average been the worst four-month stretch of the year for the Nasdaq composite index, according to the Stock Trader’s Almanac.

The issue for investors is largely one of valuation: After the spring market rally, prices of many stocks are historically high relative to depressed 2001 earnings expectations. If 2002 estimates must be further reduced as well, investors may balk at maintaining share prices at current levels.

The market almost always rallies before an earnings revival begins, analysts note, but the lead time can vary. If investors doubt a recovery in profits will occur before mid-2002, stocks could easily go lower before they go higher.

Paul McEntire, manager of Marketocracy Technology Plus Fund, based in Silicon Valley, said Friday that he has sold “short” shares of several tech companies, such as the Internet hosting firm Exodus Communications, that “may have good products but also business plans that have never demonstrated profitability.” In a short sale, an investor gains if the share price falls.

“This is a market that could be very soft for three to six months, maybe even a year,” McEntire said.

“This market correction is dramatic, but let’s not forget how huge the run-up was that preceded it,” he said. “This is taking values back to more reasonable levels after an abnormal, unsustainable run.”

Even so, with a three-to-five-year investment horizon, McEntire remains bullish on tech leaders such as EMC, AMD and chip-equipment maker Applied Materials.

Stovall noted that, historically, the market has rallied smartly in the six months to a year after a series of interest rate cuts. The Federal Reserve has cut rates six times this year, and some analysts expect more cuts ahead.

Meanwhile, energy prices appear to have topped off, and the coming rebates and fatter paychecks stemming from the federal income tax cut are expected to boost consumer spending soon.

Despite near-term earnings woes, “It’s hard for me to get scared out of the market today,” Stovall said. “Looking ahead six months or more, things should be pretty good” for stocks.

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Bottoming Out?

Analysts expect earnings for companies in the Standard & Poor’s 500 index to perk up in the second half, but some data trackers say those projections appear overly optimistic.

Year-over-year percentage change in reported or expected per-share earnings for each quarter of 2001:

QI: -6.1%

QII: -17.6%*

QIII: -6.7%*

QIV: +4.8%*

*Estimated

Confession Season

Earnings warnings, or “negative pre-announcements,” are down from the same point in the first quarter--but running far higher than a year earlier.

Pre-announcements:

*--*

Period Total Negative Positive Neutral Second quarter ’01 1,053 721 167 165 First quarter ’01 1,153 808 160 185 Second quarter ’00 366 217 60 89

*--*