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U.S. Equity Strategy (Q312 Earnings Recap) - November 16, 2012

U.S. Equity Strategy (Q312 Earnings Recap) - November 16, 2012

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Published by dpbasic
by Ryan Lewenza, Senior U.S. Equity Analyst, TD Waterhouse (TD PAIRRL) November 16, 2012
by Ryan Lewenza, Senior U.S. Equity Analyst, TD Waterhouse (TD PAIRRL) November 16, 2012

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12/22/2012

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Report prepared by:
Ryan Lewenza, CFA, CMTV.P., U.S. Equity StrategistDonato Scolamiero, CFAV.P., U.S. Equities
This Document is for distributionto Canadian clients only.Please refer to Appendix A in thisreport for important information.
Highlights
 
Q3/12 earning season was mixed with reported revenues disappointing whileearnings results came in better-than-expected.
 
The percentage of companies within the S&P 500 Index (S&P 500) that beatconsensus revenue estimates declined from 66% in Q1/12 to 40% in Q3/12, whichis the lowest ‘beat rate’ for reported revenues during this recovery. S&P 500 Y/Yrevenue growth is projected to be flat in Q3/12 with energy (-14.7%) and materials(-6.4%) posting the weakest growth rates.
 
While companies had a difficult time beating revenue estimates, they fared a lotbetter on the bottom-line with 71% of companies that reported beating earningsestimates. Q3/12 earnings are projected to be up modestly at 1-1.5% Y/Y, which istracking about 3% higher than earlier estimates.
 
 All told we would give the Q3/12 earnings season a C+ rating, with the weaker top-line results overshadowing the better-than-expected earnings results.
 
Forward earnings expectations still remain too high in our view and are likely to berevised lower in the coming months. With our expectations of slowing earningsgrowth, we believe companies that can continue to grow earnings at higher andmore dependable growth rates than the market will likely be rewarded withpremium valuations. To this end we screened for companies in the S&P 500 thathave expanded sales at least 5% and EPS 10% on a Y/Y basis in each of the lastfour quarters. Of the stocks that made the list, we would highlight
Apple Inc.(AAPL-Q), Visa Inc. (V-N), Family Dollar Inc. (FDO-N), Schlumberger Ltd.(SLB-N), CVS Caremark Corp. (CVS-N)
and
Stericycle Inc. (SRCL-Q).
 
Exhibit 1: S&P 500 Forward Earnings Estimates Look Lofty In Our View
November 16, 2012
S&P 500 Consensus EPS Estimates
$90$95$100$105$110$115$120$125Jan-10Apr-10Jul-10Oct-10Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12
Source: Bloomberg Finance L.P. As of November 12, 201220112012E2013EConsensus EPS estimatescontinue to decline.
 
U.S. EquityStrategyNovember 16, 2012Page 2
Q3/12 Earnings Recap – A Focus on Earnings Growth
The Q3 earnings season is beginning to wind down and we wanted to provide our assessment of the quarter and highlightthe key trends that stood out. Overall, reported revenues disappointed while earnings results came in better-than-expected. Highlights for Q3 include:
 
The percentage of companies within the S&P 500 that beat consensus revenue estimates declined from 66%in Q1/12 to 40% in Q3/12, which is the lowest ‘beat rate’ for reported revenues during this recovery (Exhibit2). The utilities sector reported the lowest beat rate (9.7%), with only 3 of the 31 companies in the indexreporting better-than-expected revenues. Materials and industrials also faired quite poorly, with a beat rate of 25.8% and 28.1%, respectively. Financials was the stand-out sector, posting a 64.6% beat rate on revenues.
 
S&P 500 Y/Y revenue growth is projected to be flat in Q3/12 with energy (-14.7%) and materials (-6.4%)posting the weakest growth rates, while financials (+6.7%) and information technology (+6.2%) expected toreport the strongest revenue growth rates.
 
While companies had a difficult time beating revenue estimates, they fared a lot better on the bottom-line with71% of companies that reported beating earnings estimates, which is above the long-term average of 62%. Admittedly, the bar had been lowered going into the quarter with many companies pre-announcing and, inturn, analysts revising their numbers lower; nonetheless, the 71% earnings beat was a positive surprise. Froma sector perspective, health care and financials were the positive outliers, with beat rates of 87.5% and77.8%, respectively.
 
Q3/12 earnings are projected to be up modestly at 1-1.5% Y/Y, which is tracking about 3% higher than earlier estimates. Financials are accounting for the bulk of the upside earnings surprise with financials posting a25.7% Y/Y increase in earnings for the quarter. Not surprisingly, materials and energy posted the weakestearnings growth rates of -26.8% and -20.6%, respectively. All told we would give the Q3/12 earnings season a C+ rating, with the weaker top-line results overshadowing the better-than-expected earnings results. With profit growth slowing to a stall speed, the question is whether this will continue or reverse and see a reacceleration of earnings growth into 2013? Our hope is for the later, but our belief is in the former. Onthe following pages we will outline why corporate earnings expectations may be a bit lofty and why focusing on qualitygrowth is an important investment factor during these periods.
Exhibit 2: Top-Line Revenues Were Weak in Q3/12 While Bottom-Line EPS Was Better Than Expected
S&P 500 Quarterly Sales Beat Rate
67%60%63%68%69%73%61%56%66%42%40%0%10%20%30%40%50%60%70%80%90%Q1/10 Q2/10 Q3/10 Q4/10 Q1/11 Q2/11 Q3/11 Q4/11 Q1/12 Q2/12 Q3/12
Source: Bloomberg Finance L.P. As of November 12, 2012
 
Total Positive Positive %Positive Positive %S&P 500454 / 50018239.9%32470.7%
Energy42 / 432252.4%2457.1%Materials31 / 31825.8%1548.4%Industrials57 / 611628.1%4070.2%Consumer Disc64 / 802234.4%4773.4%Consumer Staples34 / 421235.3%2676.5%Health Care48 / 521735.4%4287.5%Financials81 / 815164.6%6377.8%Information Tech60 / 702745.0%4371.7%Telecom8 / 8450.0%450.0%Utilities31 / 3139.7%2064.5%
Source: Bloomberg Finance L.P., PAIR. As of November 12, 2012
Sales BeatEPS Beat
 
U.S. EquityStrategyNovember 16, 2012Page 3 As we have been highlighting for some time now, forward earnings expectations still remain too high in our view and arelikely to be revised lower in the coming months. First, we point to the plurality of negative pre-announcements for Q4/12. According to Thomson Reuters as of November 2, “in the S&P 500, there have been 43 negative EPS pre-announcements issued by corporations for Q4 2012 compared to 9 positive EPS announcements”. That results in acurrent negative/positive pre-announcement ratio of 4.8 (Exhibit 3), which is well above the long-term average of 2.3. Thisto us shows that corporate managers see increased challenges into year-end, which is not currently reflected in futureearnings expectations. Currently, the consensus estimate for S&P 500 Q4/12 EPS is $25.80, which equates to 9.6% Y/Ygrowth. Given the continued weakening trends in global growth and the likely negative hit to U.S. GDP growth stemmingfrom Hurricane Sandy, we believe the projected 9.6% Y/Y growth expectation for Q4/12 may be too high, and could berevised lower in the coming weeks.Looking into 2013 we see a similar trend. For 2013 analysts are predicting S&P 500 earnings of $114.96, which wouldequate to growth of 10.6% Y/Y. Again, we believe these forward estimates look lofty, as we are forecasting earnings toremain basically unchanged for 2013 at $102.25. Our forecast assumes modest revenue growth and some margincompression. It is important to emphasize that we do not see earnings collapsing in 2013, rather we see earnings growthbegin to moderate as we enter the fourth year of this recovery.
Exhibit 3: Q4/12 Negative Pre-Announcements Could Result in Future Negative EPS Revisions
S&P 500Pre announcements Total (#)Total (%) Total (#)Total (%)
Positive9161114In-Line610810Negative43775875Total 5877
N/P Ratio4.785.27
Source: Thomson Reuters. As of November 2, 2012
Q4/12Q3/12
 
With our expectations of slowing earnings growth, we believe companies that can continue to grow earnings at higher andmore dependable growth rates than the market will likely be rewarded with premium valuations. To this end we screenedfor companies in the S&P 500 that have expanded sales at least 5% and EPS 10% on a Y/Y basis in each of the last four quarters. As seen in Exhibit 4 on the following page, 44 companies passed the screen. In the table we also included, for information purposes, the average growth rate for revenue and EPS during the past four quarters, along with estimatedEPS growth rates for 2013 and the long term. From the list, we would highlight
Apple Inc. (AAPL-Q), Visa Inc. (V-N),Family Dollar Inc. (FDO-N), Schlumberger Ltd. (SLB-N), CVS Caremark Corp. (CVS-N)
and
Stericycle Inc. (SRCL-Q).
 
S&P 500 Consensus EPS Estimates
$90$95$100$105$110$115$120$125Jan-10Apr-10Jul-10Oct-10Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12
Source: Bloomberg Finance L.P. As of November 12, 201220112012E2013EConsensus EPS estimatescontinue to decline.

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