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Tuesday, April 12, 2022
Today’s newsletter is by Emily McCormick, a reporter for Yahoo Finance. Follow her on Twitter
This week, first-quarter earnings season begins in earnest with the big banks, from JPMorgan Chase (JPM) to Goldman Sachs (GS), posting results.
And this earnings season, there will be one clear factor separating the winners from the losers.
“Really, what the market’s going to be focused on is margins: How are corporates being able to manage the increased inflation and cost input inflation that they’re seeing come through,” Erin Browne, PIMCO portfolio manager, told Yahoo Finance Live. “That’s going to be the key differentiator for stocks.”
Margins are a closely watched measure of profitability every earnings season. But in an environment in which inflation is running at 40-year highs and has yet to show meaningful signs of peaking, the ability for companies to maintain pricing power and pass on the higher costs to consumers has taken on increased importance.
Generally speaking, profit margins for S&P 500 companies are expected to shrink in the first quarter, compared to the previous quarter and 2021. That’s especially true for non-energy firms that have gotten hit by soaring oil and other energy commodity prices seen so far in 2022.
As David Kostin of Goldman Sachs points out, consensus analysts are looking for S&P 500 aggregate margins to contract by just 5 basis points to reach 11.8% in Q1 compared to last year. But excluding energy stocks, that decline will likely be more pronounced, with margins compressing by 58 basis points compared to last year. Notably, energy has been by far the best-performing S&P 500 sector this year, jumping nearly 40% so far in 2022, compared to an almost 7% decline in the broader index.
But that’s not to say energy stocks are the only place to look for margin resilience this earnings season. Kostin’s team put together a list of major companies that have historically maintained “high and stable gross margins.” These companies span a variety of sectors and industries, from Alphabet (communication services) with a five-year average margin level of 57%, to Tapestry and Lululemon (consumer discretionary) with 69% and 54%, respectively. Others include Coca-Cola (61%) in consumer staples, TransUnion (53%) and CoStar Group (76%) in industrials, and Adobe (85%) and Oracle (76%) in information technology.
Eva Ados, ERShares chief operating officer, also offered a vote of confidence for technology stocks when it comes to maintaining margins, even as tech shares overall have come under pressure for much of this year.
“What’s unique about tech companies is that in an inflationary environment, they can still satisfy the investors because they’re nimble, they’re flexible, and they can stop chasing revenues if they choose to,” Ados told Yahoo Finance Live. “They can change the equation between their margins and their revenue growth.”
“We’re going to see lower SG&A [selling, general and administrative] costs, lower marketing spends, lower revenue growth, but bigger margins,” she added. “That’s going to satisfy investors.”
On the flip side, Kostin also highlighted a series of stocks with “low and variable gross margins,” or typically low pricing power. These included Live Nation Entertainment and Disney in communication services with five-year average margin levels of 17% and 33%, respectively, along with Wynn Resorts (20%) and Las Vegas Sands Corp. (31%) in consumer discretionary, Hormel Foods Corporation (20%) in consumer staples, and Lockheed Martin (13%) in industrials, to name a few.
To be sure, this quarter, these companies may ultimately deliver margins better or worse than these historical averages suggest. But these do provide reference points for how firms have in the past managed to sustain margins over multiple quarters — and show that firms even in the same industries can have disparate success rates in preserving profitability.
But even as some firms are able to continue passing on costs, companies across the board are expected to endure rising expenses in the first quarter, as the cost of everything from labor to energy and raw materials rise.
As FactSet notes, of the nearly two dozen early earnings reports in the S&P 500 that had posted first-quarter results through April 7, labor costs and ongoing supply and demand imbalances remained some of the biggest callouts.
“Labor costs and shortages have been cited by the highest number of companies in the index to date as a factor that had a negative impact on earnings and revenues in Q1, or is expected to have a negative impact on earnings or revenues in future quarters,” FactSet’s John Butters said in a note Friday. “Of these 20 companies, 13 (or 65%) have discussed a negative impact from this factor. After labor shortages and costs, COVID costs and impacts (12) and supply chain costs and disruptions (12) have been discussed by the highest number of S&P 500 companies.”
In the next few weeks, we’ll see which companies have most effectively been able to navigate these concerns.
What to watch today
Economy
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8:30 a.m. ET: NFIB Small Business Optimism, March (95.0 expected, 95.7 during prior month)
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8:30 a.m. ET: Consumer Price Index, month-over-month, March (1.2% expected, 0.8% during prior month)
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8:30 a.m. ET: CPI excluding food and energy, month-over-month, March (0.5% expected, 0.5% during prior month)
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8:30 a.m. ET: CPI year-over-year, March (8.4% expected, 7.9% during prior month)
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8:30 a.m. ET: CPI excluding food and energy, year-over-year, March (6.6% expected, 6.4% during prior month)
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8:30 a.m. ET: CPI Index NSA, March (287.413 expected, 283.716 during prior month)
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8:30 a.m. ET: CPI Core Index SA, March (289.188 expected, 287.878 during prior month)
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8:30 a.m. ET: Real Average Hourly Earnings, year-over-year, March (-2.6% prior, revised to -2.5%)
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8:30 a.m. ET: Real Average Weekly Earnings, year-over-year, March (-2.3% prior, revised to -2.2%)
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2:00 p.m. ET: Monthly Budget Statement (-185.5 billion expected, -$216.6 billion prior)
Earnings
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6:50 a.m. ET: Albertsons (ACI) is expected to report adjusted earnings of $0.65 per share on revenue of $16.9 billion
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7:30 a.m. ET: CarMax (KMX) is expected to report adjusted earnings of $1.32 per share on revenue of $7.4 billion
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