The earnings focus lately has been on the Retail sector and this week’s reporting docket keeps the spotlight firmly on the space. The Wal-Mart (WMT) and Macy’s (M) reports were generally positive, with both companies showing positive same-store sales growth and strong momentum in their online (or omni-channel) businesses.

Both of these stocks didn’t do much following the releases, but that’s likely more a function of the market’s trade worries that have been weighing on the indexes lately rather than disappointment with the results. The trade issue is very much real for both of these companies given their China-sourced merchandise. Margins in the space have been under pressure for some time as these companies have been spending on their digital offerings and tariffs add another negative variable to their margins outlook.

The market hasn’t been treating Macy’s and Wal-Mart well even before their earnings releases. Wal-Mart shares have lagged the broader market this year, but they are still up +9% (vs. +14.2% gain for the S&P 500 index), but Macy’s and the broader department store space been real laggards lately.

The chart below shows the year-to-date stock market performance of Macy’s, the Zacks Department Store industry and the S&P 500 index.

The issues plaguing the department store space are longstanding and not new. These include the operators’ struggles with adjusting to the changed retail landscape characterized by consumer dollars steadily shifting to the online medium. The challenge for these companies is to hold onto their revenues and margins as they bring their operations in-line with the changed ground realities. But transitions are never smooth, easy and cheap. It is the inherent difficulties of this transition that explains the performance challenge facing these stocks. The potential margin impact of China tariffs only add to their woes.

These issues will be front and center this week with Nordstrom (JWN), Kohl’s (KSS), TJX Cos. (TJX), J.C. Penney (JCP) and other department stores on the docket to report quarterly results. Target (TGT), Home Depot (HD), and Lowe’s (LOW) are some of the other retailers reporting results this week. In total, we will have Q1 results from more than 100 companies this week, including 24 S&P 500 members.

Q1 Earnings Season Scorecard (as of Friday, May 17)

We now have Q1 results from 459 S&P 500 members or 91.8% of the index’s total membership. Total earnings for these 459 companies are up +0.2% from the same period last year on +4.7% higher revenues, with 76.9% beating EPS estimates and 59.3% beating revenue estimates.

The proportion of these companies beating both EPS and revenue estimates is 51.2%.

Retail Sector Scorecard

We now have Q1 results from 21 of the 39 retailers in the S&P 500 companies. Total earnings for these 21 retailers are up +17.9% from the same period last year on +9.4% higher revenues, with 81% beating EPS estimates and 47.6% beating revenue estimates. The comparison charts below put these results in a historical context.

The comparisons charts above provide a mixed picture, with EPS beats tracking above historical periods while revenue beats are on the weak side. With respect to growth, earnings growth is tracking below what we had seen from the same group of 21 retailers in the past, but revenue growth has accelerated.

Please note that the Zacks Retail sector also includes the online vendors like Amazon (AMZN) and restaurant operators like McDonalds (MCD) in addition to the traditional brick-and-mortar operators. Most of the 21 retailers that have reported Q1 results already are either online vendors or restaurant operators, with Macy’s and Wal-Mart as the first major traditional retailers to come out with results.

Amazon’s +118.6% higher earnings on +17% higher revenues in Q1 is likely having an outsized bearing the sector’s growth picture. The comparisons charts below show the reported growth picture with and without the Amazon numbers.

Looking at Q1 expectations as a whole for the sector by combining the actual results that have come out with estimates for the still-to-come companies, total Retail sector earnings are expected to be up +10.9% on +7.1% higher revenues. Excluding Amazon, the sector’s Q1 earnings would be up a mere +2.2% from the same period last year on +6% higher revenues.

3 Takeaways from the Q1 Earnings Season

Here are the three trends that are clearly visible this earnings season.

First, the growth challenge is very real. This is no surprise and has been well known for a while now, giving rise to the so-called ‘earnings recession’ narrative. Regular readers know our views about the so-called ‘earnings recession’ narrative this year. For reference, check out Earnings Recession Fears Are Exaggerated

The comparison chart below puts the earnings and revenue growth pace for these 459 index members in historical context.

This tough comparison on the growth front is due to the tax-cut boost to corporate profitability in 2018. The growth picture is expected to start improving in the second half of the year and accelerating into next year, with full-year 2020 earnings growth for the index reaching double digits after a +2% growth in 2019.

The moderation in this year’s growth also reflects the deceleration in global economic growth. The global GDP growth picture appears to have stabilized and even started improving in China and some other parts, but the pace is nevertheless expected to be below what we experienced in the last two years.

The bearish narrative is that we have reached the end of the economic cycle when growth inevitably turns south. Macroeconomic data doesn’t support this narrative currently, but these things are hard to decipher in real time anyway.

My reading of the economic tea leaves is a lot more favorable. While I acknowledge the weakness in Europe, the outlook for the U.S. economy continues to be positive, with growth modestly below the preceding year’s level, but still very stable. The stronger than expected Q1 GDP growth rate reconfirms this view, even though the elevated GDP growth reading benefited from a couple of ‘lower quality’ drivers. And other key regions of the world, particularly China, are showing signs of ‘green shoots’.

We will know either way as we move through the rest of this year, but my money is on continued growth.

Second, driving the earnings growth challenge is widespread margin pressures across all major sectors. While the pace of revenue growth has come down as well, but the top-line deceleration is a lot less pronounced than is the case with earnings.

Net margins for the 459 index members that have reported results are 11.7%, which compares to 12.2% for the same group of index members in the year-earlier period, as you can see in the comparison chart below.

A big reason for this margin issue is the tough comparisons to last year when margins got a big boost from the tax-cut legislation. But some cyclical factors are at play as well, with many companies on the earnings calls complaining about rising material, transportation and payroll costs.

Third, and most importantly, estimates for the current period (2019 Q2) have been coming down as companies have been reporting Q1 results and sharing their outlook for business trends.

Total Q2 earnings for the S&P 500 index are expected to be down -1.5% from the same period last year on +4.4% higher revenues, with the growth pace steadily coming down in recent days.

That said, the pace and magnitude of negative revisions to Q2 estimates is lower than what we had been seeing at the comparable period in the preceding quarters.

The chart below shows the evolution of Q2 earnings growth expectations in recent weeks.

Expectations for 2019 Q1 As a Whole

Looking at Q1 as a whole, combining the actual results that have come out from the 459 S&P 500 members with estimates for the still-to-come companies, total earnings for the are expected to be down -0.1% from the same period last year on +5% higher revenues.

Driving the expected Q1 earnings decline is broad-based margin pressures across all major sectors, with net margins for the index of 11.4% down from 12% in the year-earlier quarter. Net margins are expected to be below the year-earlier period for 5 of the 16 sectors, including the Technology sector (more on Tech margins below).

The table below shows the summary picture for 2019 Q1, contrasted with what was actually achieved in the preceding period.

As you can see above, net margins for the index are expected to be 60 basis points below the year-earlier level, with margins notably weak in the all-important Technology sector, with 2019 Q1 net margins for 19% below the year-earlier period’s 21.2% level.

The chart below shows the sector’s Q1 net margins picture in the context of where margins have come from and where they are expected to go.

The chart below shows earnings and revenue growth expectations for 2019 Q1 (the blended growth picture) contrasted with what we had in the preceding four quarter and what is expected in the following three quarters.

Expectations for 2019 Q2 and the following quarters will evolve further as the remaining companies report Q1 results and provide commentary about ground-level business conditions. We will be keeping a close eye on this revisions trend.

For an in-depth look at the overall earnings picture and expectations for Q1, please check out our weekly Earnings Trends report Can Q1 Earnings Reports Help Retail Stocks?