Global stocks: Earnings season takes off

… And the first-quarter results are in for Louis Vuitton, CSX, Schlumberger and Harley-Davidson.

Why do we devote so much time to earnings reports? Well, for one thing they are one of the main near term drivers for stocks and markets and it’s all about expectations.

We have flagged the importance of company earnings in a number of previous publications, notably in Opportunities in a robust US earnings season on November 17 last year. In many of my company recommendations the starting point has been a previous earnings report.

Fortunately investors are now able to access the company’s earnings call on the day by bringing up the company’s website and visiting the “investor relations” section. I highly recommend subscribers take advantage of this if only for the sake of interest. Believe me it is educational and entertaining.

The earnings report may be in the form of an audio file, a webcast or via a phone hook-up. Transcripts, press releases and explanatory slides are also usually available. Replays (recorded) are available for those who don’t want to get up early. Investors should pay particular attention to the Q&A at the end of the presentation where most of the Wall Street analysts who follow the company ask the “hard” questions. Never before have retail investors had such great access to company announcements.

What to look for in earnings reports

So what should we be looking for? First and foremost how has the company done versus analyst’s consensus estimates? Has the company met or exceeded earnings per share estimates, have revenues been better or worse than expectations, and have profit margins met or exceeded previous company guidance and market expectations? If the company hasn’t at least met expectations is the explanation reasonable? Currency, “one offs”, write downs, timing of product launches, etc. can all lead to shortfalls.

Most companies (although not all) will also provide guidance for the next quarter or even year for earnings, revenues and profitability. Do they exceed the consensus? Many companies are extremely conservative in providing guidance (Apple is one) so it may not closely match analyst expectations.

The direction of the stock price in the aftermarket or the next day will tell you if the market is happy or not with the result and forward guidance.

As I said in my Nov 17 Eureka article, “If a company reports earnings well above consensus (usually on higher revenues) and raises guidance, analysts will usually raise their future earnings assumptions in the form of a positive earnings revision. This is the “perfect storm”. Upward earnings revisions are one of the most powerful factors driving stock prices.”

So far, stocks out of our international recommendations that have reported first quarter results so far include Louis Vuitton, CSX, Schlumberger and Harley Davidson.

Louis Vuitton (LVMH)

Louis Vuitton reported results on April 14, 2015. Group sales growth was above consensus at 3 per cent year-on-year in constant currency terms.

This is a respectable report given the tough comparisons in the Japanese business that saw a 32 per cent sales gain in last year’s first quarter, driven by attempts to beat a VAT increase on the first of April.

On the analyst call the company flagged better than expected growth in Europe (10 per cent versus 5 per cent in the fourth quarter of 2014), and good sales momentum in the US (9 per cent), with most divisions reporting double digit year-on-year growth with the exception of watches (Apple Watch effect?).

Regionally Asia Pacific remained mixed due to the Hong Kong protests and reduced Macau tourism. The company increased European prices 3 per cent at Vuitton but left pricing unchanged in other regions.

By division year-on-year organic growth at constant currency terms was the following:

  • Perfumes & cosmetics ( 6 per cent) driven by Dior fragrances and make-up.
  • Watches & jewellery ( 7 per cent) saw accelerating trends in Bulgari jewellery and Hublot watches.
  • Selective retailing ( 5 per cent) with duty free stores (DFS) mixed and strong growth from Sephora at the double digits like-for-like globally.
  • Wine and spirits (-1 per cent) affected by Chinese distributors destocking but offset by US strength.
  • Fashion and leather ( 1 per cent) had tough Japanese comparisons, as mentioned above.

As we flagged in our initiation piece on LVMH, forex (EUR/USD) remains a real tailwind providing a 12 per cent group sales growth pickup across the board. Most analysts missed this in their estimates.

Our take: There is no change in our “buy” thesis on LVMH, with the company executing well across all lines of business. LVMH is on track to a return to double-digit earnings growth in 2015 following two years of subdued earnings.

CSX (CSX)

CSX had a solid first quarter generating earnings per share (EPS) of $US0.45, a penny ahead of market expectations. Revenues of $US3.027bn were also slightly ahead of consensus with favourable fuel expense sand higher productivity savings providing the beat.

CSX posted all-in core pricing of 1.6 per cent and 3.4 per cent for merchandise and intermodal. Volume increases were seen in minerals ( 11 per cent) driven by strength in coke and iron ore tonnage, and chemicals ( 6 per cent). Coal was down 1 per cent.

Guidance was positive as CSX reiterated its double digit EPS growth target in 2015 and surprised positively with a $US2bn share buyback.

On the conference call chief executive Michael Ward stated, “CSX will continue pricing ahead of rail inflation, growing Merchandise & Intermodal faster than the economy and improving efficiency which is expected to produce savings approaching $200m this year.”

Chief financial officer Frederick Eliasson provided a broader but generally positive outlook for the second quarter:

“We expect a generally flat demand environment in the second quarter. We expect strong intermodal growth to continue as our strategic network investments support highway to rail conversions and growth with existing customers. Increased infrastructure development products are driving a favorable outlook for minerals. Agriculture is neutral as strengthened domestic grain shipment is offset by weakened export grain market resulting from the strong US dollar. Automotive is expected to grow modestly driven by projected North American light vehicle production.

The outlook for chemicals market is also neutral due to a reduction in drilling activities stemming from the low commodity price environment. As a result we expect crude volumes from the remainder of the year to hold relatively flat to the level we saw in the first quarter. We have sustained low natural gas prices under $US3, domestic coal volumes was adversely impacted in the first quarter and we expect volume to decline in the second quarter and to be down at least 5 per cent for the full year.”

Our take: These are decent results and much better than peers in a somewhat difficult operating environment. They should improve.  There’s no change to our “buy” rating.

Schlumberger (SLB)

SLB delivered better than expected results in the face of major market headwinds, delivering adjusted EPS of $US1.06 which beat consensus by an impressive 19 per cent, or 17 cents.

Margins held up better than anticipated in all markets as internal efficiency initiatives helped mitigate the margin decline. The company also generated free cash flow of $US1.2bn during the quarter (a 74 per cent year-on-year increase) and continues to buy back stock with 8.7m shares repurchased.

Revenues for the quarter fell 19 per cent sequentially (down just 9 per cent year-on-year), but at $US10.2bn the results were just slightly lower than consensus forecasts of $US10.4bn. North American revenues of $US3.2bn were in line, falling 25 per cent sequentially on a decline in both pricing and activity. Revenues in the Middle East/Asia-Pacific region were 5 per cent below forecast on large declines in China, Asia-Pacific, and Australia. Latin America was 6 per cent below forecast, while revenues in Europe were in line.

Amongst SLB’s product segments, drilling held up the best, falling just 15 per cent on a decline in rig count in North America and unfavourable currency effects in Russia and Venezuela. The reservoir characterisation and production groups witnessed a sequential 20 per cent and 22 per cent decline in sales.

In terms of guidance the chief executive reiterated (in a press release) that the North American business would be difficult:

“The largest drop in E&P investment is occurring in North America, where 2015 spend is expected to be down by more than 30 per cent. We believe that a recovery in US land drilling activity will be pushed out in time, as the inventory of uncompleted wells builds and as the re-fracturing market expands. We also anticipate that a recovery in activity will fall well short of reaching previous levels, hence extending the period of pricing weakness.”

The company also announced it would be slashing its workforce by 11,000 employees, adding to 9000 cuts earlier in the year as a way of stringently controlling costs in an uncertain environment.

Our take: Considering the headwinds facing SLB and its peers, the company clearly has its “eyes on the ball” in terms of maintaining profitability and is pulling no punches in candid outlook comments. In my opinion this is the service name to hold in this environment and we do expect the oil price to move higher this year.  Since year end 2014 the stock has gained 9 per cent versus 2.7 per cent for the S&P500.

Harley-Davidson (HOG)

Harley’s results were mixed. The company beat consensus earnings expectations by US$0.03 on better margins but sales volumes were disappointing, falling year-on-year by 1.3 per cent to 56,661 units.

In the US, volumes declined by 0.7 per cent to 35,488 units on what the company characterised as aggressive discounting by competitors (especially the Japanese). Parts and accessories revenue were down 7.2 per cent to $US183.87m.

The gross margin for the motorcycles segment was up 1.4 percentage points to 39.1 per cent while operating margins were 0.8 percentage points to 22.9 per cent. This is a decent result on the margin front.

Harley’s guidance for the rest of 2015 was disappointing, however. The company expects shipment growth of 2 per cent to 4 per cent for the year, down from a prior outlook of 4 per cent to 6 per cent. While this isn’t a disaster, it’s not what the market wanted to hear. An operating margin of 18 per cent to 19 per cent seen for the full year was about in line with expectations and similar to 2014.

The stock was weak on the results, declining to $US55.70 during the trading day.

What to do here? The stock has underperformed year-to-date in positive market environment. However, the first quarter is a small and volatile quarter and is often unduly affected by the weather. Sales could easily turn-around in the spring/summer selling season.

Also, I don’t (as a “bike guy” and Harley owner) see the Japanese bikes as natural competitors. They look like Harleys but they aren’t Harleys. Polaris Industries’ Victory motorcycle manufacturer and Indian brands, while still small in the scheme of things, do bear watching, however. 

I’m going to give the company the benefit of the doubt here and continue to recommend the stock. Harley is now trading at just 11.7 times 2016 EPS. It looks like a buying opportunity for long term investors at these levels.

Looking across the S&P500

Looking at first quarter earnings estimates for the S&P 500 in aggregate, analysts actually expect earnings to decline some 4.5 per cent year-on-year.

Cause for alarm? Not really, since it’s the energy sector (14 per cent of the S&P 500) that’s dragging things down with estimates falling 60 per cent. Outside of the energy sector, the S&P500 is expected to grow earnings 3.4 per cent year-on-year. 

From an industry perspective, healthcare and technology should continue their winning ways, as should consumer discretionary companies, hopefully benefitting from cheap gas and growing consumer confidence.

From a big picture standpoint, multinationals will be dealing with a strong dollar which may crimp reported earnings and forward guidance. It’s not always a linear relationship however because companies can and do hedge. Longer term of course, a strong currency can make the company’s products more expensive for foreign buyers and lead to some erosion of competiveness.

Given the relatively tepid global economy, it will be interesting how global companies characterise the demand environment and it which regions they see strength and weakness. I’ll be particularly interested on how demand in European and Chinese markets are faring.

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