LDN - Business

For first time in a decade, U.S. companies could report lower profits on higher revenue

[April 15, 2019] By Caroline Valetkevitch

NEW YORK (Reuters) - Wall Street is bracing for large U.S. companies to report a decline in quarterly profits even after raking in higher revenues, something that has not happened in more than a decade.

S&P 500 companies due to report in the coming weeks face tough comparisons with last year, when the U.S. tax code overhaul helped boost profits by more than 20%.

But with rising costs, some resulting from tariffs, analysts see profit margins shrinking by 1.1 percentage point, the first year-over-year decline in at least two years, IBES data from Refinitiv showed.

"Companies are experiencing rising input costs as well as increases in labor costs from modestly rising wages," said Kristina Hooper, chief global market strategist at Invesco in New York.

First-quarter earnings for S&P 500 companies are expected to fall 2.5% from a year earlier, which would mark the first quarterly U.S. decline since 2016. Revenue is meanwhile seen up 4.8%.

Costs for certain raw materials like aluminum have increased as the United States slapped tariffs on imports from China and other countries.

First-quarter earnings could be crucial to the bull market's continued success, with some investors seeing them as the catalyst to either lift stocks to all-time highs or pour cold water on the rally.

Stocks have bounced back from a late-2018 selloff on optimism that the United State could seal a trade deal with China and expectations the Federal Reserve would not raise interest rates again any time soon.

Delta Air Lines Inc is due to report on Wednesday, while JPMorgan Chase & Co and Wells Fargo & Co report on Friday. Results from Netflix Inc and some big industrial names like Honeywell International Inc are expected next week.

DIVIDED OUTLOOK

The last time profits fell while revenue grew was the third quarter of 2008, in the depths of the financial crisis. Still, strategists appear divided on what the rest of the year holds for earnings.

It is also not unusual for S&P 500 companies to top analyst expectations.

Since 1994, S&P 500 earnings have beaten estimates by an average of 3.2%, based on Refinitiv data, and some strategists think the S&P 500 will end up posting growth for the first quarter.

And nearly 83% of earnings are beating analysts' expectations so far this quarter, based on the 23 S&P 500 companies that have already reported.

"Earnings bars for the first quarter are so low companies are going to trip over them," said Nick Raich, chief executive of The Earnings Scout, an independent research firm.

Projected sales growth through the rest of the year may also help investors look through any first-quarter margin dips.

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A car waits to enter the financial district security zone near the New York Stock Exchange (NYSE) in New York City, U.S., March 23, 2017. REUTERS/Brendan McDermid

"Revenue growth has been extremely stable throughout 2018 and is expected to remain so in the year ahead," Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities in New York, wrote in a note on Monday.

"We believe that investors will focus on the breadth and consistency of top-line results, versus 1Q margin pressures," wrote Golub.

WARNING SIGNS

Other strategists are more cautious. First-quarter results are likely to mark the start of an S&P 500 profit recession, defined as two consecutive quarters of earnings declines, according to Michael Wilson, Morgan Stanley's equity strategist.

"Our earnings growth leading indicator suggests (the first quarter) won't be the trough for this year," Wilson wrote in a note.

Warning signs are coming from technology companies, with semiconductors, which have a large revenue exposure to China, seen among the most sensitive to the trade conflict.

Tech stocks have outperformed the broader market so far this year, but Wilson said the sector had the biggest percentage of companies missing fourth-quarter margin estimates even as the number of management comments on margin expansion reached new highs.

Year-over-year first-quarter earnings for S&P 500 tech companies are expected to fall 6.1%, according to Refinitiv.

Wilson said margin results will be important to watch, and that wage pressures appear to be rising. He noted that the number of mentions of labor costs during earnings calls in the last reporting period was the highest since 2005.

But first-quarter performance is expected to be uneven across sectors.

Profit margins are eroding for several heavily weighted companies including Apple Inc and Exxon Mobil Corp, but not across the board for S&P 500 companies, Golub said.

Despite a first-quarter surge, oil prices were still down from last year, and earnings from the S&P 500 energy sector are expected to drop 21.2%.

The rallying dollar will likely be a negative for U.S. multinational companies, whose foreign currency earnings are worth less when the dollar is stronger.

The dollar rose 6.2% on a trade-weighted basis in the quarter, its strongest performance on a year-over-year basis since the fourth quarter of 2015.

The dollar gains could mean a 2.4 percentage point drag on earnings in the quarter, said Binky Chadha, chief U.S. equity and global strategist and head of asset allocation at Deutsche Bank in New York. But, he said, that drag is likely to lessen from here.

(Reporting by Caroline Valetkevitch; additional reporting by Lewis Krauskopf in New York; Editing by Alden Bentley and Meredith Mazzilli)

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