by Greg Harrison.
Second-quarter earnings guidance looks extremely weak, with 93 of the 116 preannoucements negative. The healthcare sector has the most negative N/P ratio, and the consumer discretionary sector is also very negative.
With the first-quarter earnings season mostly complete, investors are anticipating second-quarter earnings results. First-quarter earnings growth is currently at 5.0%, up from the 1.5% that analysts were predicting at the beginning of earnings season. Second-quarter earnings expectations are similarly low, with 2.8% growth currently forecast. This is down from the 6.1% estimate from the beginning of April. While some of the decline is likely due to the normal seasonal estimate revision pattern, company-issued guidance has not helped.
Of the 116 second-quarter earnings preannouncements given by S&P 500 companies, 93 of them have been negative, while only 14 have been positive. The resulting 6.6 negative to positive guidance ratio is the most negative since the first quarter of 2001. As seen below in Exhibit 1, the recent trend has been toward more negative preannouncements as earnings growth has slowed. While there is still more guidance to come as the second-quarter earnings season approaches, the N/P ratio as it stands is significantly more negative at 6.6 than for the first quarter, which itself was the most negative since Q3 2001, at 4.3. Over the long term, there have been 2.4 negative preannouncements for each positive one.
There are significant differences between the sectors when it comes to guidance. Some sectors, such as consumer discretionary and information technology, are more likely to issue guidance, whereas others whose earnings are more dependent on market prices, like utilities and financials, are more reluctant to do so. Exhibit 2, below, depicts the N/P ratio by sector. The consumer staples, financials and industrials sectors are not shown in the chart, as no companies in these sectors have issued positive guidance, preventing the calculation of N/P ratios.
The healthcare sector has the most negative N/P ratio, at 13.0. Companies in this sector typically provide very conservative guidance relative to analysts’ estimates. Despite this, some of the negativity in the sector goes beyond being conservative and gives a window into real concerns held by management teams. Agilent Technologies Inc. (A) gave EPS guidance of 62 cents, when analysts were predicting 73 cents at the time — a 15% difference. The company’s CEO, Bill Sullivan, gave a candid outlook on the global economic recovery and its effect on Agilent’s earnings. On a May 15 earnings call, he said, “I actually thought there was some likelihood of recovery in the second half of the year. And it’s just a hard reality, it’s not happening. There are continued issues in the U.S. and Europe, Japan stimulus hasn’t kicked in, China is going to grow at 7.5% to 7%. We are not going to get the type of revenue growth that is going to be able to maintain our margins.”
Consumer discretionary has also been very negative, with 21 negative preannouncements versus only two positive ones. Discount retailers have benefitted from cost cutting in households as consumers have traded down to less expensive stores. However, even Dollar Tree, Inc. (DLTR) disappointed analysts with its second-quarter guidance, which was 5% lower than previous analysts’ estimates. Bob Sasser, the company’s CEO, gave his perspective on the store’s consumers during the company’s May 23 earnings call. He explained, “We still think they’re concerned and burdened and, I would add, just a bit weary from all that’s going on. They’re now facing higher taxes and overall less money to spend, and add to that the job concerns that are still there, and the uncertainty around the economy.” In addition to anticipated weak spending in the United States, exporters are concerned about foreign currency effects on earnings. Tiffany & Co. (TIF) expressed concern about sales in Japan due to the weaker yen, and issued guidance that was 8% lower than the consensus estimate at the time.
While analysts have looked at the guidance issued so far and adjusted estimates accordingly, it remains to be seen whether these negative outlooks are a result of companies trying to play it safe in an uncertain environment, or if the concerns that have been expressed will affect other companies that haven’t provided guidance, potentially leading to weaker earnings than are currently anticipated.