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By Ronald Fink
With all but a few of the S&P 500 companies having
reported their second quarter earnings, a study today finds that investors are
overestimating the health of corporate profits.
As of August 7, earnings for 446 of the 500 companies had
fallen by a share-weighted average of almost 30 percent from the same period a
year ago, according to a report by Simon Ballard, an analyst for research firm
CreditSights.
The only sector to report an increase for the second quarter
was health care, where earnings advanced by 7.6% from a year earlier. Earnings
for two other sectors, utilities and consumer staples, fell a relatively modest
2.8 percent and 0.7 percent, respectively.
In contrast, profits for the two worst-performing sectors,
energy and materials, fell by 67.1 percent and 65.3 percent, respectively,
according to the study. The next-worst performing sectors were industrials,
where earnings were down 35.5 percent, and financials, down 33.4 percent. They
were followed by telecoms, down 24 percent, consumer discretionary, down 16.1
percent, and information technology, down 15.5 percent.
With the stock market nonetheless up sharply during the
quarter, the CreditSights report noted that investors were evidently impressed
with the fact that these results beat expectations. “Set your sights low enough
and a 100 percent ‘positive surprise’ could be achieved,” Ballard wrote. But he pointed out that such a result
shouldn’t be confused with real growth in earnings. “To then use such a result
to assume robust corporate profitability would obviously be wrong,” the analyst
added.
Ballard also observed that virtually all of the positive
earnings surprises have been achieved through cost cutting, which isn’t
sustainable. “There has been next to no evidence of revenues or sales volumes
increasing,” he wrote. As a result, he noted, many companies have been guiding
analyst estimates for the rest of the year downward.
He also noted that companies have not done all that much to
improve their creditworthiness, notwithstanding some high-profile examples of
deleveraging. And he predicted that corporate defaults would increase markedly
during the second half of the year as a result.
While Ballard noted that credit conditions have improved in
recent months, he observed that “access to the public or the bank debt markets
remains far more limited to would-be high-yield borrowers.”
The analyst also noted that “there is a big difference
between short-term earnings profiles being buoyed and long-term profitability
issues being addressed.” And he warned that most companies continue to hoard
cash.
“We need to see robust corporate investment and long-term
strategic planning," wrote Ballard. "And for the time being this
remains conspicuous by its absence.”
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