Q2 Earnings Season Winding Down

[Pages:28]August 24, 2016

Zacks Earning Trends

Sheraz Mian

SMian@

Q2 Earnings Season Winding Down

The bulk of the Q2 earnings season is now behind us, with results from 483 S&P 500 members already out. Total earnings for these companies are down -3.2% on +0.1% higher revenues relative to the same period last year, with 72.3% beating EPS estimates and 54% coming ahead of top-line expectations.

The focus lately has been on the Retail sector, with a number of leading operators like Wal-Mart (WMT), Macy's (M), Nordstrom (JWN) and others coming out with positive surprises and a favorable outlook. These positive reports notwithstanding, the sector's overall earnings performance is still on the weak side. Driving this weakness has been the steady decline in foot traffic as a result of sales moving online. With many of these operators struggling to deal with this shift in consumer behavior, Amazon (AMZN) has been able to gain share by offering a compelling user experience.

Amazon's steady gains in the apparel space is a big reason for the pain in the traditional department store space. The positive results from the likes of Macy's and others this earnings season is not reflection of a better competitive response to Amazon & Co, but largely a function of factors that will likely not endure beyond the next couple of quarters. These factors include improvement on the inventory front and very low department store expectations. Inventories finally appear to be in-line with sales, which come after two back-to-back quarters when these operators were saddled with mountains of unsold merchandize as a result of weather and the aforementioned reduced foot traffic issue.

Unlike the department stores, the improvement in Wal-Mart results appear to be more enduring, with the retail giant not only doing a better job at improving its core physical retail operations (cleaner stores, better assortment and improved customer experience), but also coming out with a credible digital response to the Amazon challenge. WalMart's online efforts still have a long way to go, but they have been doing a lot more on that front, even prior to the purchase, than most of its peers.

Retail Sector Scorecard

We now have Q2 results from 38 of the 44 retailers in the S&P 500 index that combined account for 94.1% of the sector's market capitalization in the index. Total earnings for these retailers are up +3.9% from the same period last year on +4.2% higher revenues, with a below index average 60.5% beating EPS estimates and a very low of 44.7% coming ahead of revenue estimates.

The side-by-side charts below compare the results thus far half of the retailers in the index with what we have seen from the same group of retailers in the recent past.



Zacks Earning Trends

August 24, 2016

As you can see, the earnings and revenues growth rates in the left hand chart are about in-line with historical periods. But the proportion of retailers coming out with positive EPS and revenue surprises in the right hand side chart are tracking significantly below historical periods. In other words, while growth is about in-line with historical periods, but this is weaker than what was expected.

We know that Amazon had a blockbuster earnings report, which likely is giving the growth pace a helping hand. Taking the Amazon results out of the Retail sector results thus far, total earnings for the rest of the space are actually down -0.2% from the same period last year on +2.5% higher revenues.

The charts below show the growth comparison, with and without the Amazon earnings report

This shows that the retail sector's respectable growth pace at this stage is solely due to the Amazon report. Once we take Amazon out of the sector's results at this stage (right hand side chart), then the sector's growth pace turns out be a lot weaker.



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Zacks Earning Trends

August 24, 2016

Q2 Earnings Season Scorecard

For Q2 as a whole, we now have results from 483 index members, with total earnings for these companies down -3.2% on +0.1% higher revenues relative to the same period last year.

The side-by-side charts below compare the results from the 483 index members with what we saw from the same group of companies in other recent periods. The left-hand chart compares the earnings and revenue growth rates with historical periods while the right-hand chart is doing the same comparisons for positive EPS and revenue surprises.

Here are the four takeaways from the results thus far:

First, the earnings growth remains negative, but is nevertheless an improvement over what we saw from the same group of 483 S&P 500 members in the preceding quarter (2016 Q1) and the 4?quarter average. We may be putting too fine a point by calling a decline of -3.2% as an improvement over a decline of -4.5% (the 4-quarter average), but the Q2 decline is nevertheless an improvement over the preceding quarter.

Second, revenue growth is ever so slightly in the positive (+0.1%) for this group of 483 index members. As is the case with earnings growth for these companies, it is an improvement over what we saw from this group of 483 S&P 500 members in 2016 Q1 and the average for the preceding four quarters.

These earnings and revenue growth comparisons largely remain in place even after we exclude the Energy sector's substantial drag from the reported results. Total earnings for the Energy sector are down -78.9% on -24.4% lower revenues from the same period last year. Excluding the Energy sector, earnings for the remainder of S&P 500 members that have reported results would be up +0.4% from the same period last year on +2.9% higher revenues.



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Zacks Earning Trends

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The comparison charts below show the growth picture with and without the Energy sector.

Third, positive EPS surprises for the 483 index members that have reported results are tracking modestly above the 4- and 12-quarter averages. This suggests that Q2 estimates may not have been that low after all. Positive revenue surprises, on the other hand, are moderately tracking below other historical periods.

Fourth, estimates for the current period (2016 Q3) have come down, following a wellestablished historical trend. Total Q3 earnings for the S&P 500 index are currently expected to be down -2.8% from the same period last year, which is a decline from expectations of flat earnings at the start of the quarter.

The chart below shows the evolution of Q3 earnings growth expectations



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Zacks Earning Trends

August 24, 2016

Please note that while the trend of negative revisions to Q3 estimates is in-line with the recent past, the magnitude of negative revisions is not. In other words, estimates for Q3 are not falling by as much as was the case at the comparable stages in other recent reporting cycles.

Estimates for all 14 sectors have come down since the beginning of July, but they have come down the most for the Auto sector and the least for the Aerospace sector. The Auto sector weakness is primarily a function of sharp drop in Ford's (F) estimates while Technology's relatively improved estimates revision picture is due to positive momentum for Facebook (FB) and Alphabet (GOOGL) offsetting modest declines at other sector players.

Estimates Beyond Q2

The chart below shows (the blended) Q2 growth expectations contrasted with what was actually achieved in the preceding four quarters and estimates for the following four periods. Full-year 2016 earnings growth expectations have now turned negative, similar to what we saw last year.



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Zacks Earning Trends

August 24, 2016

Beyond the current period (September quarter), meaningful growth is expected to resume from Q4, which is then expected to continue into 2017. Easier comparisons for the Energy sector arrive in Q4, when the sector's earnings growth turns positive. But the expected growth in Q4 and beyond isn't solely a function of easy comparisons for the Energy sector ? the expectation is for positive momentum from a broad cross section of sectors. Those expectations will most likely need to come down. But it will be interesting to see to what extent they will have to come down.

Q2 Earnings Season Now Largely Behind us

Including all of this morning's reports, we now have Q2 results from 483 S&P 500 already. Total earnings for these companies are down -3.2% from the same period last year on +0.1% gain in revenues, with 72.3% beating EPS estimates and 54% coming ahead of top-line expectations.

The table below shows the updated Q2 Scorecard.



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Zacks Earning Trends

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Note: Here are few key points to keep in mind while reading this report. a. All the earnings analysis in this report pertains to the S&P 500 index, a handy proxy for the entire

business world. We use the index's current membership as the basis for all period comparisons, meaning that even historical periods reflect the index's current membership. b. We divide the corporate world into 16 sectors compared to the official S&P 10 GICS. We have standalone sectors like Autos, Construction, Conglomerates, Aerospace, Transportation and Business Services that provide for a better understanding of trends in these key areas of the economy. c. All references to `earnings' mean `total earnings' and not `mean or median EPS'. d. We make adjustments to reported GAAP earnings to account for non-recurring or one-time items, but we do consider employee stock options (ESOs) as a legitimate business expense. Unlike Zacks, Wall Street and all other data vendors don't treat ESO's as a recurring business expense.

The first column of this table shows the percentage of each sector's members in the S&P 500 index have already reported results. As you can see, the Retail sector is the only sector at this stage that has any sizable number of reports still awaited at this stage, with the reporting cycle coming to an end for ten sectors already.



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Zacks Earning Trends

August 24, 2016

Sectors with the highest growth rates include Conglomerates (earnings are up +20.6% on -0.1% revenues), Autos (+16.3% earnings growth on +5.2% higher revenues), and Utilities (+8.3% earnings growth on -1.5% lower revenues). Of these three, only Auto sector reports have been better than expected, with 81.8% beating EPS estimates and 72.7% beating revenue estimates. The Construction sector has the lowest proportion of positive EPS surprises of all 16 Zacks sectors, and revenue beats percentages for the sector are the lowest as well.

The sectors with the highest proportion of positive surprises include Medical and Aerospace.

The Finance Sector

For the Finance sector, we have seen results from 100% of the sector's total market capitalization. Total earnings for these Finance sector companies are down -5.2% from the same period last year on +1.8% higher revenues, with 66.7% beating EPS estimates and 54.4% coming ahead of revenue estimates.

The chart below compares the sector's Q2 results thus far with what these same companies had reported in other recent periods.

As you can see, while the growth picture isn't much to write home about, results have nevertheless been better than expected. The proportion of finance companies coming out with positive EPS and revenue surprises is far more numerous than has been the case in the past. With respect to earnings and revenues growth rates, while earnings growth is about in-line with the preceding period, revenue growth is tracking above the prior-quarter's level.



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