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Corporate fundamentals weaker than investors think: study Print E-mail
Tuesday, 11 August 2009

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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