Q3 Earnings Season Mostly Behind Us Now

Q3 Earnings Season Mostly Behind Us Now

We don’t have much in terms of earnings releases this Thanksgiving Day week, but we still have 69 companies releasing results, including 7 S&P 500 members. The Q3 earnings season is mostly behind us, with results from 486 S&P 500 members already known. Most of this week’s reports are coming out on Tuesday, including Hewlett-Packard (HPQ), Tiffany (TIF), and Hormel Foods (HRL). By the end of this week, we will have seen Q3 results from 493 of the S&P 500 members.

The focus lately has been on the Retail sector and we have a number of retailers coming out with results this week as well. Investors have broadly been happy with the results from some of the sector leaders like Wal-Mart (WMT), Target (TGT) and Macy’s (M). But that’s likely more due the extremely low expectations than absolute outperformance. The effect of the secular migration of traffic from the physical domain to the digital one has been an ongoing issue with the sector leaders, though a number of these players are starting to see the online offering as an integral part of their overall customer experience. But it’s still an evolving picture.

Macy’s omni-channel strategy has been one of the most successful execution of this concept in the space. But Wal-Mart, which came out with positive Q3 results on the back of first same-store sales growth in the home market, has been making good progress on its online presence. The company has been making aggressive investments in its online presence and that has started showing up in its results. Wal-Mart’s online sales were up +21% in Q3, a solid performance but lower than the first-half 2014 growth pace of about +27%. The recent drop in gasoline prices has been beneficial to Wal-Mart’s target market and will raise hopes for a better holiday season in that market segment.

On top of these structural issues facing the industry, retailers have to contend with the still-weak condition of household finances. The labor market is no doubt improving and that has started to show up in measures of consumer confidence. But wage growth has been essentially stagnant, restricting households’ buying power. The recent drop in gasoline prices should help this holiday season, but overall it has been a tough backdrop for retailers. No doubt the stock-price performance of the retail sector in the S&P 500 has been one of the weakest in the index – up +8% vs. a gain of +11.6% for the index as a whole in the year-to-date period.

Sector Results Thus Far

With respect to the sector’s performance thus far, total earnings for 40 Retail sector companies in the S&P 500 that have already reported Q3 results are up +2.4% on +5.3% higher revenues, with 67.5% beating earnings estimates and 55% coming ahead of top-line expectations. This is the second lowest earnings growth performance of all 16 sectors (Autos is the weakest) in the index. The earnings growth rate for the sector is roughly in line with what we have been seeing from the sector in other recent quarters, as you can see in the chart below.

But the beat ratios tell a different story; these mediocre results came as a positive surprise to investors. As you can see in the chart below, the earnings and beat ratios for the sector are tracking better than we have seen from the same group of companies in other recent quarters.

What this means is that expectations for the sector were too low, proving an easy to beat hurdle rate for many sector players. Low expectations also appear to be the most reasonable explanation for how the market reacted to the sub-part results from Macy’s (M).

The Q3 Scorecard (as of November 21st)

The Q3 earnings season has come to an end for 11 of the 16 Zacks sectors, with results from 486 S&P 500 members already on the books. Total earnings for these companies are up 6.9% from the same period last year, with 71.1% of the companies beating earnings estimates. Total revenues are up 4.1% and 57.0% have come ahead of top-line estimates.

The chart below shows the current Q3 Scorecard.

As you can see, the earnings growth rate for 7 of the 16 Zack’s Sectors is in double digits, with Basic Materials (+17.6%), Construction (+17.2%), and Medical (+15.3%), having the strongest growth rates. The Materials strength isn’t a reflection of increased demand for this economically sensitive sector in these troubled times, but relatively easier comparisons for the Chemicals (the largest industry in the sector) and Steel industries. Total earnings for the Chemicals industry, which alone accounts for roughly two-thirds of the Basic Materials sector’s total earnings, are up +23.9% on +4.5% higher revenues.

The chart below shows the industry level scorecard for the Basic Materials sector.

On the flip side, we have just one sector with negative signs on the growth front, Autos down -21.6%. We know that the automakers were struggling with product recalls and the Retail sector still has plenty of reports to come. The hope is that the falling gasoline prices will help the sector this holiday season.

‘Average’ Grade for Q3 Earnings Season

Our grade for this earnings season remains ‘average’ – it isn’t good, but it isn’t bad either. To explain our ‘average’ grade, we share two types of charts below that will show how the results thus far compare with the past and what is happening to estimates for the current period (2014 Q4).

The two side-by-side charts below compare the results thus far with what we had seen from the same group of S&P 500 members in Q2 and other preceding quarters (the 4-quarter Average is the four quarters through 2014 Q2).

The left hand side chart shows the growth rate for earnings (orange) and revenues (green) and the right side chart shows the beat ratios. The data in these charts is for the 486 S&P 500 companies that have reported Q3 as of Friday November 21st.

As you can see, it’s hard to make one all-encompassing narrative for the reporting cycle, other than to say that it’s not materially different from what we have been seeing from these companies in other recent quarters, particularly on the growth front. Beat ratios appear to be diverging from the norm a bit – with Q3 earnings beats ratios tracking above recent levels while revenue beat rates are on the weak side.

One could argue that this isn’t a bad performance and we are harsh in giving this reporting cycle an ‘average’ grade. That’s a fair comment, but our grade also reflects how the results thus far, particularly management guidance, are impacting estimates for the current period (2014 Q4)

The chart below shows what happened to Q4 estimates as companies released Q3 results. As you can see, estimates moved down.

This negative revision trend isn’t new either – we have been seeing this quarter after quarter for more than two years now. In some respects, the pace and magnitude of the negative revisions at this stage is exceeding what we had been seeing at comparable stages in the last few quarters.

The Energy sector’s travails resulting from the declining oil prices is well known and is a big reason why the magnitude of revisions for Q4 are so pronounced relative to other recent quarters. But Energy is hardly the only sector suffering negative revisions; the trend is broad based as the chart below shows.

The Composite Picture

The table below shows a composite (or blended) summary picture of Q3 combines actual results from the 486 S&P 500 members that have reported with estimates from the remaining 14 index members. As you can see, total earnings are expected to be up 6.8% from the same period last year on 4.1% higher revenues and modest margin gains. The expected growth rate for Q3 has been steadily improving in recent days as companies report results and beat estimates.

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Note: For a complete analysis of 2014 Q3 estimates, please check out our weekly Earnings Trends report.

Here is a list of the 69 companies reporting this week, including 7 S&P 500 members.

TARGET CORP (TGT): Free Stock Analysis Report
MACYS INC (M): Free Stock Analysis Report
HORMEL FOODS CP (HRL): Free Stock Analysis Report
HEWLETT PACKARD (HPQ): Free Stock Analysis Report
TIFFANY & CO (TIF): Free Stock Analysis Report
WAL-MART STORES (WMT): Free Stock Analysis Report


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