Revenue Weakness Stands Out In Q3 Reports

The Q3 earnings season ramps up in a big way this week, with 436 companies reporting quarterly results, including 114 S&P 500 members. With results from 58 index members already out, we will have seen Q3 results from one-third of the S&P 500 members by the end of this week.

The Finance sector has a heavy presence in the reports thus far and the sector’s earnings performance is lackluster at best. We knew the operating environment was tough for banks in the quarter, with modest gains in core loan portfolios offset by soft capital markets activities in a backdrop of persistently compressed net interest margins as a result of Fed policy. As a result, bank revenues are down, with bottom-line growth primarily coming from cost cuts and fewer litigation expenses.

As of Friday, October 16th, we have seen Q3 results from 15 of the 85 Finance sector companies in the S&P 500, but these 15 companies account for 39.3% of the sector’s total market cap in the index. Total earnings for these 15 Finance sector companies are up +18% on -2.6% lower revenues, with 66.7% beating EPS estimates and 33.3% coming ahead of revenue estimates. The two side-by-side charts compare the sector’s results thus far with what we had seen from the same group of Finance sector companies in other recent periods.

What the above comparison charts show is that the results thus far are weaker relative to other recent periods on all counts, except for earnings growth that is tracking notably better relative to both Q2 as well as the 4-quarter average. The revenue picture is particularly notable for its weakness, both in terms of growth rate as well as surprises. The earnings growth comparison is misleading as the Q3 growth is primarily a result of easy comparisons at Bank of America (BAC). The chart below reproduces the left-hand chart above, but excludes Bank of America from the numbers this time.

The revenue weakness isn’t confined to the Finance sector – the issue is present in all the other sectors as well, which will likely become very obvious on this week’s busy docket.

Q3 Scorecard (as of Friday, October 16th)

With Q3 results from 58 S&P 500 members already on the books, total earnings are up +3.9% on +0.1% higher revenues, with 69.0% beating EPS estimates and 41.4% coming ahead of top-line expectations. The table below provides the current Q3 scorecard.

The charts below provide a comparison of the results thus far with what we have seen from this same group of 58 S&P 500 members in other recent periods.

Any way you look at it, this is weak performance relative to the recent past, with revenue surprises particularly standing out for their weakness. Please note that the +3.9% earnings growth for the index at this stage gets a lot of help from the easy comparisons at Bank of America referred to earlier. Excluding Bank of America, the earnings growth picture is a lot weaker, as the reproduction of the growth comparison chart below on an ex-BAC basis shows.

These numbers will move around as we get into the heart of the earnings season this week and beyond. But what all of this shows is that the top-line weakness, which was a big issue in the Q2 earnings season, doesn’t appear to be changing this time around either.

Q3 Estimates As a Whole

Combining the actual results from the 58 S&P 500 members that have reported results with estimates for the still-to-come reports, total earnings for the index are expected to be down -4.5% from the same period last year on -4.8% lower revenues.

The headwinds from Q2 are at play in Q3 as well, with a combination of Energy sector weakness, dollar strength and global growth uncertainties weighing on the outlook. Excluding the drag from the Energy sector (Energy sector earnings expected to be down -64.5% year over year), total earnings for the index would be up +2.8% on +0.2% higher revenues.

Energy stands out for the wrong reasons, as briefly mentioned earlier, but it is hardly the only one with negative earnings growth in Q3. In fact, half of the 16 Zacks sectors are expected to have lower earnings in 2015 Q3 relative to the year-earlier period, with Basic Materials (-24.3%), Industrial Products (earnings decline of -23.9%), and Conglomerates (-7.3%) as the big decliners.

On the positive side, the Finance sector is expected to have positive growth.  But that’s largely thanks to easy comparisons at Bank of America, as indicated earlier. Other sectors with positive earnings growth in Q3 include Autos (+19.8%) Transportation (earnings growth of +19.1%), Medical (+8.6%), and Construction (+7.4%). Total earnings for the Technology sector are expected to be up +2.3% from the same period last year, but the sector’s growth rate drops into negative territory once Apple’s (AAPL) strong contribution is excluded from the numbers.

The table below presents the summary picture for Q3 contrasted with what companies actually reported in the 2015 Q2 earnings season.
 

Looking Beyond Q3

The chart below shows current consensus earnings growth expectations for the coming quarters contrasted with what is expected for Q3 and what was actually achieved in Q2. Estimates for Q4 have started to come down, with total earnings for the S&P 500 index now expected to be down -5.2% from the same period last year, which is down from an expected decline -4.7% last Friday. The Finance and Energy sectors are having the opposite effects on the aggregate growth picture for Q4, as is the case in Q3. Excluding Finance, total Q4 earnings would be down an even bigger -9% while removal of the Energy drag results in flat earnings for the S&P 500 index relative to the same period last year.

Economists define two back-to-back quarters of negative GDP growth as a recession. If the Q3 earnings growth rate stays in the negative territory as currently projected, then we will be well within out rights to call it an earnings recession. As you can see in the above chart, analysts expect the earnings growth picture to start turning around next year and really accelerate towards the back-half of 2016.

The relatively optimistic looking expectations for the outer periods aren’t unusual – Wall Street analysts always tend to be more optimistic about the future. But estimates start coming down as the period in question comes closer. The erosion of 2015 growth estimates was driven largely by what happened to the Energy sector. But estimates for other sectors came down as well…and we will likely see something similar to current 2016 estimates as well.

Here are this week’s key earnings reports:

Monday (10/19) – Morgan Stanley (MS) and Halliburton (HAL) are the notable reports in the morning while IBM (IBM) will report after the close.

The Schlumberger (SLB) report has likely stolen the thunder from what Halliburton could say about the state of the oil patch. But Halliburton has a much bigger presence in the U.S. onshore region, whose health is of immense significance to the outlook for oil production growth.

Estimates for Morgan Stanley came down over the past month, with the current EPS estimate of 66 cents down from 73 cents a month back. On the whole, they should be better placed relative to Goldman Sachs (GS) and others as they have less of a fixed income exposure and equities did reasonably well in Q3, judging from the results we have seen already.

Tuesday (10/20) – Of the 22 S&P 500 members coming out with results today, Verizon (VZ) and Travelers (TRV) are the notable reports in the morning session while Yahoo (YHOO) and Chipotle (CMG) will report after the close.

Wednesday (10/20) – On a busy reporting day, we have 30 S&P 500 members coming out with Q3 results. Boeing (BA), Coke (KO) and General Motors (GM) are the key reports before the market’s open while eBay (EBAY) and Texas Instruments (TXN) are the notable reports after the close.

Thursday (10/21) – With 46 S&P 500 companies reporting results today, Caterpillar (CAT),3M (MMM), Eli Lilly (LLY) and Southwest (LUV) are on the docket to report before the open while AT&T (T) and Amazon (AMZN) report after the close.  

Friday (10/23) – Proctor & Gamble (PG) and American Airlines (AAL) are the notable reports today, both in the morning.

Here is a list of the 436 companies reporting this week, including 114 S&P 500 members.