Target and Microsoft may be just the beginning of a worrisome earnings trend
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Target won’t be the only company that has a bullseye in the coming earnings season. Tuesday’s warning came from Target for the second consecutive month, saying that inventory shortages would cause a drop in profits. This new advice comes days after Microsoft issued another highly publicized warning that its revenues would suffer from unfavorable foreign currency rates. Analysts expect more companies to issue profit warnings. When quarterly reports begin to come out in July, it is likely that more companies will fall short of their estimates. “Companies will need to begin guiding less and more conservatively. Brian Rauscher from Fundstrat, global portfolio strategist at Fundstrat said the input costs and other issues that they are facing still have not disappeared. There are interest rate pressures. The dollar will be your currency. This is a time of uncertainty unless you are very clear about your visibility on the end demand. Target updated Tuesday to say that profits will be squeezed as it moves aggressively to clear out unwanted products from its shelves. Target surprised investors less than one month ago when it reported a earnings loss and decreased its earnings forecast. Some retailers’ inventories have increased as consumers shift to other categories and the number of Covid cases dropped. Consumers also returned to activities such as social events. Inflation is also a factor, particularly as gasoline prices continue to rise and food costs have risen. Patrick Palfrey from Credit Suisse, senior equity strategist said that inflation is starting to affect certain segments of the market. Revenue revisions are moving up. The earnings revisions moved higher up until these last few weeks. But they were doing so at a slower speed. Now, we are seeing margins start to fall. Investors closely monitor margins. They simply measure the difference in money that a company spends and the money it brings in. Palfrey stated that he anticipates a more polarization around margins. Palfrey stated that companies with higher margin momentum would have more operating leverage. They also benefit from the “underlying trends”. Companies with lower margin momentum, I think are at risk of margins becoming negative and can lead to businesses slowing down. Palfrey noted that second-quarter earnings revisions for communications and consumer discretionary companies have been the most severe. Since the start of the year, about 35% of the S & P 500 companies have had positive earnings revisions for the second quarter. In the second quarter of 2018, the earnings outlooks for companies included in the index rose by on average 0.3%. Only 9% reported improved prospects for their second quarter, while only 0.3% of companies in communications services saw this. Credit Suisse reports that around 86% saw energy earnings estimate increases by an average of 88.3% for the quarter. The estimates for materials companies increased by about 50% in the second quarter. This is an average increase of 15%. Palfrey indicated that second quarter earnings will grow just 5.2%, which is half of the 11.7% growth seen in the previous quarter. However, he expects a recovery to 10.6% in the third quarter. However, strategists caution that the analysts are not adjusting numbers as low as they should be and that the stock market could react negatively to several warnings or misses. I believe companies will continue to feel the effects of margin pressure. Palfrey said that those companies are likely to feel the pinch of margin pressure “will be penalized.” It all comes down to the management’s ability and willingness to adapt to changing environments. Credit Suisse rated companies in the S & P 500 based on their margin momentum. Chevron was among the companies with positive momentum. Stocks with low margin momentum versus the S & P 500 include Walmart, Amazon, Ford, Colgate-Palmolive and Starbucks. According to strategists, there are many factors that could impact profit prospects in this economy. These include the increasing price of oil and other energy. Palfrey said that “The dollar represents an incremental hurdle for companies. It’s not a major one, but it’s something companies will focus on,” especially for companies with lower pricing and cannot pass on the increased input costs efficiently. Technology companies can’t pass that through as well, while material and energy companies do better. Rauscher indicated that he expected to see an increase in pre-announcements between next week, and July. Rauscher stated that he believes large numbers of companies will beat their expectations for the second quarter. However, like the trend in the first quarter they also have a negative outlook. Although he anticipates a decline in profits due to companies responding to the economic downturn, it isn’t clear how much and when. For many overseas companies, the 15 percent increase in dollar does not yet factor into the earnings. “What do corporate America and analysts do? Rauscher said. Rauscher said, “Is this a slow bleed? Or is it going to occur during the summer months when everyone starts to decrease their numbers?” That data has not been compiled on consumers is what he points out. “The Fed tightens. This is not going to improve consumer spending. Crude oil is rising. Rauscher stated that this affects a variety of other aspects, including gasoline prices and energy bills. “Unless crude fell $30, and we could change this dynamic, the consumer is only going in one direction — it’s flat to down in my opinion.” Although he said that Target is not the only retailer facing similar problems, he pointed out that Walmart also has commented on these issues.
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