by David Aurelio.
The second quarter of 2019’s earnings season has arrived and analysts have become increasingly bearish. Analysts currently estimate S&P 500 year-on-year (YoY) 19Q2 earnings will decline 0.1%; however, a year ago expectations for the index were for an increase of 10.6%. Anticipation of margin compression is one of the reasons for the decline in earnings expectations.
Exhibit 1: S&P 500 YoY 19Q2 Earnings Estimate History
Part of the reduction in growth is due to a stronger than expected 18Q2 earnings (80.2% of companies beat estimates), which led 19Q2 YoY estimates to fall to 9.2% by Oct. 1, 2018. It is also worth noting that we typically see analysts become more bearish going into earnings season and make downward revisions to earnings estimates. As a result, YoY earnings growth expectations typically fall four percentage points (ppts) from the start of the quarter to the start of earnings season. 19Q2 YoY earnings were expected to increase 0.2% on July 1st , which was only a 1.4 ppts decline from the 1.6% May 1, 2019 estimate. Therefore, analysts’ revisions are less bearish than historical averages. Although a deep dive reveals that analysts do expect to see margin compression.
Exhibit 2: S&P 500 Margins
Second quarter 2019 net profit margins are expected to contract 0.6 ppts to 11.8% from the prior year. Nine of the 11 sectors are expected to see YoY net profit margin contractions. The information technology (-2.6 ppts) and materials (-2.2 ppts) sectors are expected to see the largest contractions while the communications services (0.9 ppts) sector is expected to see the largest net profit margin expansion.
Exhibit 3: S&P 500 Net Profit Margins by Sector
The 19Q2 20.7% net profit margin for the information technology sector is expected to be 2.6 ppts below the prior year. Pre-tax profit is expected to be 24.7%, which is 2.5 ppts below 18Q2. The largest YoY 19Q2 net profit margin contraction in the sector is expected to be seen in the semiconductors & semiconductor equipment industry group, which is estimated to see net profit margins of 26.3% in 19Q2 compared to 33.6% in the prior year. Pre-tax profit for the group is expected to contract 7 ppts to 29.3%.
The materials sector is expected to see 19Q2 net profit margins decline 2.2 ppts to 10.1% from 12.2% in 18Q2. Pre-tax profit for the sector is expected to contract 3.0 ppts to 13.2%. Analysts expect the largest margin contractions from the materials & mining industry. Net profit margin is expected to contract 8.1 ppts to 4.3% and pre-tax profit margin to fall 11.1 ppts to 9.0%.
The communications services sector is expected to see YoY 19Q2 net profit margin expand 0.9 ppts to 15.2% and pre-tax profit margin to expand 0.1 ppts to 18.7%. The interactive media & services industry is expected to see the largest margin expansions within the sector. Net profit margins of 24.2% compared to 17.9% in 18Q2 and pre-tax profit margin of 28.6% vs. 21.8% in the prior year. This is largely driven by Alphabet Inc’s (GOOGL.OQ, GOOG.OQ) 11.0 ppts net profit margin expansion to 20.8% in 19Q2 and pre-tax profit margin expansion of 11.8 ppts to 24.7%.
Exhibit 4: S&P 500 YoY Growth Expectations
Revenue is expected to increase by 3.4%; however, due to margin compression, YoY earnings are expected to decline.
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