April 16, 2012

Earnings Roundup: A Modestly Upbeat Beginning to Q1 Reports

by Greg Harrison

The first quarter earnings season kicked off in earnest in the United States last week, as Alcoa Inc (AA.N) surprised the financial markets by reporting a profit of 10 cents a share. Over the years, Alcoa’s earnings report has come to mark the official start to the quarterly announcement period given both its position near the top of any list of stock symbols, its membership among the elite 30 companies in the Dow Jones Industrial Average and its rapid reporting – this year, only about ten days after the end of the first quarter.

The positive surprise Alcoa delivered for the just-ended first quarter gave investors enough of a psychological lift to break a five-day losing streak for major market indexes. Still, Alcoa’s results contain only modestly helpful signals of what lies ahead for the rest of the S&P 500 companies. Over the last decade, Alcoa has set the trend about 59% of the time, with a positive surprise paving the way for better-than-expected earnings across the S&P 500 and vice versa, while the correlation between Alcoa’s earnings growth rate and that of the S&P 500 over the same period is 0.22. These data points offer a limited amount of insight into the earnings results for the market as a whole, even though they don’t seem to justify investors responding to the company’s positive surprise by taking a more bullish view of the earnings prospects of the entire S&P 500.

Alcoa’s surprising profit was of particular interest, however, given that analysts expect the Materials sector to be a poor performer this quarter, with an expected decline of 12.5% in the rate of earnings growth. This makes it important to look past the numbers themselves to the reason for the stronger-than-expected performance. During the company’s earnings conference call, CEO Klaus Kleinfeld said Alcoa sees “growth in all global end markets”, and particularly in China and North America (with the exception of the building and construction industry in the latter.) Business conditions are “a little softer but (we still see) good growth.” Europe is “hovering along,” he added. The wild card, and a contributor to Alcoa’s earnings, is its aerospace division, where “the market goes from strength, really, to strength”.

Of the seven companies that reported their results last week, five (71%) beat their earnings estimate. This is slightly below the rate reported for the earnings season so far, as 75% of companies have reported stronger-than-expected results to this point, but still higher than the long-term average of 62%.

Two of the bellwethers in the Financials sector reported last week: both JPMorgan Chase & Co (JPM.N) and Wells Fargo & Co. (WFC.N) both posted positive surprises and the CEOs of both banks made upbeat comments on the state of the housing market. JPMorgan CEO Jamie Dimon described the improvement in the bank’s residential real estate holdings during an earnings conference call last Wednesday, arguing that the market appears to have hit bottom. The number of “homes for sale (is) down, inventory is down, delinquent loans are coming down, charge-offs are coming down, real money is coming in.”

Wells Fargo reported a 21% increase in mortgage banking revenue and CEO John Stumpf discussed the prospects for a revival in the housing market. “When you have the dynamics of higher rental rates and lower home values at great financing rates, there is a point in time where the market is going to clear,” he said. “I think we are getting very close to that tipping point, and we have seen it” in some parts of the real estate market.

Google Inc (GOOG.O) beat earnings estimates and announced a two-for one stock split. The company’s earnings benefitted from a jump in the value of “clicks”, as well as the fact that consumers activated about 850,000 Android devices every day during the quarter. The company emphasized that more consumers are using the mobile phones to search the Internet, and benefited from the higher cost per click that advertisers are paying and higher paid click growth. At the end of the quarter, Google was sitting on a cash hoard of about $45 billion. That and the company’s “robust” profit margins give Google “the confidence to continue to fully fund … strategic growth areas such as mobile, Android, YouTube (and) Chrome”, Patrick Pichette, the company’s chief financial officer, told listeners to the company’s quarter-end conference call.

Given the better than expected results in the earnings preseason, this week’s results and the optimistic statements from companies that reported their financial performance, it seems that there is a chance that the first quarter earnings season this year will not be as dismal as analysts had been expecting.

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