First quarter U.S. corporate earnings – our initial thoughts

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In brief, the picture for US corporate earnings in the first quarter of 2016 remains mixed. With roughly a quarter of Standard & Poor’s 500 companies reporting so far, first-quarter earnings overall are coming in slightly better than already-lowered expectations.

Energy and metals and mining companies posted the worst year-over-year declines in earnings, followed by the financial sector. Technology was also a weak spot, while consumer discretionary, healthcare and the telecom sectors’ earnings were higher than last year. Earnings declined 8% versus last year’s first quarter, representing the fourth consecutive quarter of earnings decline. Many of the themes weighing on earnings growth last year carried over from the last quarter – US dollar strength, low commodity prices, low interest rates, and an ongoing focus on controlling costs. Budgets and full-year guidance are largely unchanged. Overall, revenue growth remains elusive. After four consecutive quarters of revenue declines, the first quarter did not break the pattern, showing an approximate 1% year-over-year decline.

The major US banks saw sub-10% returns on equity during the first quarter as revenue pressures weighed on returns, and the sector will continue to keep a keen eye on further cost reductions, expected across the board. Uncertainty about the global economic outlook, oil price weakness and recession concerns during the first quarter contributed to volatile markets, and reduced trading activity in both fixed income and equities. During earnings calls, many bank management teams suggested that capital markets-related revenues have improved from the low levels seen in January and February, as recession fears have abated and commodity prices have rebounded, but the energy book remains an issue for the banks, resulting in additional energy loan provisioning. Management teams expressed concerns around uncertainty from the US presidential election, political events in Europe and the interest rate outlook.

The consumer discretionary sector is the standout so far, reporting double-digit earnings growth during the first quarter, and showed a clear differentiation among the sub-sectors. Internet retail and autos continue to outperform, while traditional brick-and-mortar retailers remain under pressure. The US consumer is healthy. Housing and housing-related companies remain solid, and expectations for new home starts, and repair and remodeling trends are still favorable. Additionally, existing home sales are running above last year’s pace, led in large part by gains in the Northeast and Midwest. Inventories remain lean.

For US multinationals, a strong US dollar and slow global growth remained a drag on sales, which registered mid-single digit declines, better than the approximate ten percent decline reported in the first quarter of last year. Management teams are budgeting a full-year impact from currency and slow global growth to be similar to levels seen in the first quarter. Regionally, operations in the US are solid, and Europe is expected to remain a positive for 2016. Sales in China, while also a positive, should remain sluggish, and the environment in Brazil will stay challenging.

So far, the outlook for full-year 2016 earnings is relatively unchanged. Economic growth remains sluggish, the pipeline for M&A activity is solid, leverage continues to increase and there is no real pick-up in capital expenditures. As revenue growth remains challenging, US corporations continue to focus on controlling costs. Companies are also enjoying the benefits of lower fuel expenses, and outside of gradually rising labour costs, input cost inflation remains muted. Still, companies will need to show meaningful improvement in the second half of the year in order to meet consensus estimates. [divider] [/divider]

This article was written on 3 May 2016, in New York.

Uma Rickheeram

Head of US Credit Research

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