interactive.wsj.com
JUNE 25, 2001
Profits Without Honor
Will second-quarter earnings mark the low ebb?
By Erin E. Arvedlund
With Corporate America likely to clock the worst earnings decline this
quarter in nearly a decade, don't be surprised if the current stream of profit
warnings and doom-and-gloom announcements continues to flow. Earnings
for companies in the Standard & Poor's 500 index are forecast to decline
17.2% in the second quarter from a year earlier, the worst year-on-year drop
since the third quarter of 1991, when S&P 500 earnings slid 17.9%.
To be sure, there have been worse declines: the second quarter of 1991,
when S&P 500 earnings posted a 24.2% decline; the first quarter of 1982,
with a 20.1% decline, and the first quarter of 1975, with a 21.2% decline. All
came around recessionary nadirs. Fast forward to 2001 and a brighter picture
could develop later this year if the economy rebounds rather than recedes.
May employment and industrial-production data confirmed that U.S.
manufacturing is still in a recession, although the widely watched inventory
correction should have nearly run its course by the middle of the year,
strategists say.
But the Federal Reserve Board
has eased interest rates
aggressively, by 2 1/2 percentage
points since the start of this year,
and another quarter or half point
cut is likely this week. Plus,
Americans can expect a boost
from the Bush Administration's
long-promised tax cut: look for
refund checks of $300 for
individuals, $500 for single parents
and $600 for married couples to
hit mailboxes around the country in the next few months.
Analysts' consensus estimate is for second-quarter earnings to drop 17.2%,
while Thomson Financial/First Call's projection is for a slightly less horrid
decline of 15%. UBS Warburg's chief global strategist Edward Kerschner
forecasts S&P 500 operating earnings of $12.60 a share, not including a
20-cents-a-share or so hit for Ford's Explorer tire recall, down 14% from a
year ago. The auto maker is counting the recall as an operating charge, one
that shouldn't recur in the third or fourth quarter, Kerschner says.
Companies expected to post gains are those in defensive sectors. Analysts'
consensus estimates for S&P 500 sectors are for utilities earnings to be up
10%; health care, up 11%; energy, up 15%; financials, down 2%, and
consumer staples, up 1%. Lehman Brothers, for instance, reported
second-quarter earnings that easily beat analysts' expectations. Earnings rose
to $430 million, or $1.38 a share, compared with $378 million, or $1.39 a
share, in the same period last year. Analysts polled by Thomson
Financial/First Call expected second-quarter earnings of $1.14 a share.
Meanwhile, earnings for these S&P 500 sectors are expected to fall:
communications services, down 33%; consumer cyclicals, down 39%
(excluding the effect of Ford's charge, down 24%); basic materials, down
42%; transports, down 62%; and technology, down 64%. Obviously,
technology is the weakest link.
Meanwhile, investors shouldn't fixate on the downturn in technology, which
accounts for about 11% of S&P 500 earnings this year, down from 15% last
year. Excluding technology, S&P 500 earnings are forecast to drop just 7.4%
in the second quarter, according to First Call.
However, a closer look at the four major tech sectors -- semiconductors,
computers, software, and communications equipment -- reveals it's the latter
group that should experience the steepest drop in second-quarter profits from
a year ago. Qwest Communications still expects to meet its 2001 revenue and
earnings targets, and the broadband network builder expects second-quarter
revenue to increase 12% to 13% over the year-ago period. But Level 3
Communications, another network builder, last week forecast a loss in 2001
of about $7.50 a share, wider than the previous estimate of $7.25. Analysts
had expected Level 3 to lose $7.27 a share for the year. The company said it
expects a recovery late in 2001.
A quick look at chip earnings, via the MSCI USA Semiconductor Equipment
and Products index, shows analysts over the past three and six months have
slashed their 2001 forecasts by 49.7% and 70.7%, respectively. Forecasts
for 2002 offer little solace, says I/B/E/S analyst Joseph Kalinowski, showing
analysts slashing earnings expectations by 41.2% and 61.3% over the three-
and six-month periods.
For the third quarter, Wall Street analysts are more optimistic, predicting the
S&P 500 earnings will decline just 5.5%. But First Call's forecast is for a
much larger third-quarter earnings decline of at least 13%. "We could well
have a third quarter as bad as the second," says Chuck Hill, director of
research at First Call.
The bright spots are energy, utilities, health care, retail and consumer
nondurables. "The average earnings downturn lasts four quarters, often simply
because the fifth quarter brings easy year-on-year comparisons," Kerschner
points out. He believes this year's earnings comparisons won't get better until
the fourth quarter -- at the earliest.
So it seems the economy and stock market recovery both could hinge on how
wide-open consumers keep their wallets. "The economy is in a tug of war,"
says First Call's Hill. Wall Street expects the economy to recover, but
probably not soar, over the next few quarters. "We're on a knife-edge. The
consumer continues to spend, but will the weakness in capital spending
continue pulling us into a recession?" Hill says the earnings numbers to watch
are those in sectors such as consumer cyclicals, such as cars, housing, home
furnishings and retailing, all very sensitive to the economy.
Adds Hill: "Pre-announcements from companies such as Avnet, Solectron and
Jabil Circuit, which serves a wide range in the electronics industry, are more
significant to me than Nortel Networks." Nortel stunned Wall Street the week
before last by warning of a sharp sales drop and one of the largest quarterly
losses in corporate history. The Canadian telecom-equipment maker, the
world's largest, cited a disastrous downturn in telecommunications spending
and warned of a second-quarter loss of some $19.2 billion, mostly because of
one-time charges.
"Nortel is just one of many in a sector where we know the earnings patterns
are bad. What we are wary of are earnings pre-announcements from the
consumer cyclicals, like Maytag and Pier 1. We ascertain from them whether
economic recovery will come in the fourth quarter this year or first quarter of
next year," Hill adds. Earnings from financial-services companies "are
important too, but it's harder to predict them further out." Since deregulation,
utilities have seen their profit estimates rise every quarter, and have tended to
beat them by more than the normal margin. But that means "utilities may not
be the widows-and-orphans sector it used to be," notes Kalinowski.
Corporate-profit warnings in the second quarter are also starting to slow
apace. So far in the second quarter, 571 companies have pre-announced or
guided estimates lower, compared with 131 companies in the same period a
year ago and 610 in the first quarter. "When you're in a down period like this
the negative pre-announcements are the more important thing to watch." And
66% of all pre-announcements this quarter are negative, versus 57% on
average.
But sentiment may be turning. Of total pre-announcements, 150 were positive
in the second quarter, compared with 114 in the first quarter.
With luck, this quarter could mark the worst comparisons. That would be the
silver lining on the earnings cloud.
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