For Immediate Release
Chicago, IL – March 4, 2011 – Zacks.com Analyst Blog features: S&P 500 ETF: , General Motors (GM - Analyst Report), iShares Basic Materials ETF: (IYM - ETF report), iShares Industrial ETF: (IYJ - ETF report) and iShares US Home Construction ETF: (ITB - ETF report).
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Here are highlights from Thursday’s Analyst Blog:
Sector Watch: Cyclicals
The data is based on the bottom-up consensus estimates for each stock in the S&P 500, and is then aggregated into the economic sectors.
As a base, I present the data for the S&P 500 as a whole (same as in yesterday’s post, so you can skip it if you read it already).
S&P 500 (95.8% in)
To get an idea of how each sector will do, it is useful to have a common benchmark, such as the entire S&P 500. For the S&P 500 as a whole, earnings were up 29.6% year over year in the fourth quarter, up from 26.0% year-over-year growth in the third quarter. It is worth noting that as the earnings season began, year-over-year growth was expected to come in at just 19.8%.
What is true of the whole, must be true for at least most of the component parts. For the full year, earnings soared 44.2% for the S&P 500 as a whole in 2010. Then again, 2009 was not exactly a normal year, so it was working off some very easy comps. Growth is expected to slow to 15.0% in 2011, and then continue to fall to 12.0% in 2012 as the comparisons become more and more difficult.
Still, even the 2012 growth is pretty healthy. Revenue growth has been much slower and the market as a whole has been enjoying margin expansion, as have most of the sectors. Revenues are grew 6.86% in 2010 and expected to 4.03% grow in 2011 and then accelerate to 6.13% growth in 2012. The revenue picture (and thus the net margin picture) is significantly distorted by the Financial sector, but the distortion should fade a bit over time.
Excluding the Financials, revenues grew by 9.59% in 2010, and are expected to slow to 6.51% growth in 201 and 6.13% growth in 2012. Net margins for the whole S&P are expected to rise from 8.64% in 2010 to 9.56% in 2011, and continue rising to 10.08% in 2012. If one excludes the Financials, the margins are lower but still growing, rising to 8.80% in 2011 from 8.23% in 2010. In 2012 the net margins excluding the Financials are expected to increase to 9.31%.
The S&P 500 as a whole is selling for 15.7x 2010 earnings and 13.7x 2011 earnings expectations. If you are willing to look out to 2012 earnings the P/E ratio falls to 12.2x. The “per share numbers work out to $83.03 for 2010 and $95.47 for 2011. In 2012, they are expected to pass the century mark for the first time ever, rising to $106.83.
S&P 500 ETF:
Autos (100% in)
Earnings growth in the Auto sector fall sharply to a decline of 4.40% year over year in the fourth quarter from growth of 90.75% in the third quarter. That is mostly -- but not entirely -- due to higher base earnings in the fourth quarter of last year than in the third quarter of 2009.
However, sequentially earnings were down by 22.78% so it is not only about a higher base. Keep in mind that for most of the third quarter of 2009, two of the “big three were in chapter 11 bankruptcy. Those two firms are not part of the S&P 500 (although I would expect General Motors (GM - Analyst Report) to be added at some point in the near future; Chrysler is still not publically traded), but indirectly they did affect the other firms in the sector that are in the S&P 500.
This is a pretty small sector, particularly by number, with just six firms in it and accounting for just 1.55% of total expected earnings in 2011 (down from 1.30% in 2010). That number should increase when GM is once again a part of the S&P 500, but it will still be a small sector.
Earnings growth was stellar in 2010, rising 2,079.37%, but you should pretty much consider that the same as N/A -- more or less a question of dividing by close to zero. Growth is expected to slow to a much more normal 11.03% in 2011 and then rebound a bit to 15.57% in 2012.
While auto sales have been recovering, they are still far below the levels that were considered normal before the Great Recession. Then it was considered normal for the industry to be selling 16 or 17 million cars and trucks a year in the U.S. Sales fell to an annual rate of below 10 million in the worst of the Great Recession, and have since worked their way back to the 13.4 million level in February. For 2009 and 2010 as a whole, auto sales have been running below the rate at which we scrap cars, so there is some very real pent-up demand.
This is a relatively low margin sector, with net margins expected to rise to 5.06% in 2011 from 4.91% in 2010 (and just 0.24% in 2009). The earnings growth in the fourth quarter was a bit on the disappointing side, and as a result estimate revisions have also been on the weak side, particularly for 2011. The FY1 revisions ratio is just 0.61.
For 2012, more estimates are being raised than cut, with a revisions ratio of 1.27, but that is still below that of the S&P 500 as a whole. On a valuation basis, the sector is very attractive with a P/E of 12.5x based on 2010 earnings and 11.3x based on 2011 earnings (the lowest of any sector). I think this sector is attractive and would overweight it. However, given the relatively weak revisions ratios, you might want to pick your spots and buy on weakness, rather than chasing the stocks higher.
Basic Materials (95.7% in)
Like Autos, this is a very cyclical industry and has been enjoying very solid growth as the recovery from the Great Recession has progressed. This industry is driven by global demand, not just U.S. demand, and the strong growth in places like China and India play a very big role here.
In the fourth quarter the sector reported total earnings that are 47.3% higher than a year ago, accelerating from the third quarter growth was 41.80%. As the comparisons get tougher, the rate of growth is slowing on an annual basis as well, with total net income rising 70.95% in 2010, but falling to 34.84% in 2011 and to 13.33% in 2012. Still, that is well above the growth rate for the S&P 500 as a whole for all three years.
Revenue growth is also above the overall S&P 500 for 2010 and 2011, but is also slowing, falling from 12.78% in 2010 to 12.15% in 2011 and 5.12% in 2012. The direction of commodity prices will play a big role in both the revenue and the earnings growth of companies in this sector. With earnings growing much faster than revenues it means that net margins are rising, going from 4.47% in 2009 to 6.77% for 2010, and continuing to rise to 8.14% for 2011, and 8.78% expected for 2012. That is still below the overall S&P 600 level.
Estimate momentum is much better than average, with a revisions ratio of 2.84 for FY1 (mostly 2011) and 4.21 for FY2 (mostly 2012). That could well mean some good short-term trading opportunities in the sector. Valuations are a bit on the high side, particularly looking at the 2010 P/E of 17.9x. With the better than average growth expected for 2011, the P/E based on 2011 earnings falls below to the overall market average at 13.2x, and to 11.7x if you are willing to look out to 2012 earnings.
I like this sector from a long-term theme point of view (harder to find high-quality mineral reserves at a time when the growth of China and India are creating massive demand for things like copper and iron ore). The combination of great estimate momentum, and very strong earnings growth, along with below average valuations based on 2011 earnings makes this sector extremely attractive, and would overweight it significantly. It is a relatively small sector though, expected to account for just 6.43% of total profits in 2011, up from 2.93% in 2010, and expected to expand to 3.47% in 2012.
iShares Basic Materials ETF: (IYM - ETF report)
Industrials (95.0% in) This cyclical sector was one of the earnings growth leaders in the third quarter with total net income up 51.76% over the third quarter of 2009. The growth rate actually accelerated to 66.77% in the fourth quarter. For all of 2010, earnings were 42.58% higher than in 2009.
Looking at 2011, growth is expected to slow to “just 29.70%. That should be enough to put the sector near the top of the leader board. The higher base is likely to slow growth to 19.39% in 2012, but that is still much better than the S&P 500 as a whole.
The high growth means that the sector is picking up earnings share, rising from 1.95% of total earnings in 2010 to 2.20% of total earnings in 2011, and continuing to expand to 2.35% in 2012. That still makes it one of the smaller sectors in the index. As far as the top line is concerned, growth is comfortably above the overall market for all three years (but then again fell more than the overall market in 2009).
Total revenues were 13.76% higher in 2010 than the depressed 2009 levels. The recovery is expected to continue with 12.15% growth in 2011 before falling to a still-solid 9.30% in 2012. Net margins are expected to expand from 7.10% in 2010 to 8.15% in 2011, and grow to 8.78% in 2012.
The sector is at the very top in terms of estimate revisions, with 3.84 increases per cut for FY1 and 4.43 increases per cut for FY2. Thus, this is an area where there should be some good short-term trades to be made.
Valuations are higher than average for the sector at 20.1x 2010 earnings, but the P/E falls to 15.5x based on 2011 earnings, and to 13.0x if you want to look out to 2012 earnings. To make this sector a good long-term investment at these multiples, higher-than-average growth would have to continue into 2013. That is quite possible, but far from guaranteed. Still, given the terrific growth profile and the strong revisions, I would be inclined to overweight the sector.
iShares Industrial ETF: (IYJ - ETF report)
Construction (100% in)
This is a very battered-down sector, one that is just barely making it back into profitability in 2010 after major sector wide losses in 2008 and 2009. The year-over-year growth in the third quarter was simply massive at 1148.57%, but that really is a case of dividing by near zero.
Surprisingly after such huge growth in the third quarter, year-over-year growth actually turned negative, falling 13.72% in the fourth quarter -- and that is not because last year’s fourth quarter was great. Sequentially, earnings in the sector are expected were down 17.16% from the third quarter.
The full-year earnings growth for 2010 cannot be calculated, but looking forward to 2011, the sector is expected to do better than average with 23.90% growth, but that is not particularly impressive given the base they are coming off of. Looking ahead to 2012, growth is expected to pick up to 48.12%. Nice, but remember where it is coming from.
Revenue growth was non-existent in 2010, coming in at just 0.47%. Top-line growth is expected to accelerate to 5.99% in 2011 and to accelerate to 11.05% in 2012. Still, that makes Construction a big margin expansion story as net margins are expected to climb from 2.69% in 2010 to 3.15% in 2011, and to 4.20% in 2012. That still puts them far below the S&P 500 as a whole, but the percentage increase is by far the largest.
The estimate revisions picture does not look very good, either. For FY1, the revisions ratio is 0.34, or almost three cuts for every increase. It’s only a little bit better for FY2, at 0.42. In both cases this respresents the weakest of any sector, and by a pretty good margin.
In short this sector looks like a turnaround story that is not turning. Along with the high growth comes some very lofty P/Es with the sector selling for 36.7x 2010 earnings but falling to 29.6x based on 2011 earnings. And dropping to a more normal-looking 20.0x if the current expectations for 2012 are realized. Given the awful revisions ratio, that is a very big "if."
In fairness, the sector probably looks a lot cheaper on a book value basis than it does on an earnings basis at this point. With housing prices heading down again, I would avoid this sector entirely. The stocks in it are volatile, so you would need a pretty high risk tolerance to short it, but if you are the adventuresome type, go for it. For most people, just avoiding it like the plague should be sufficient.
It is a very small sector expected to account for just 0.27% of total earnings in 2011, up from 0.25% in 2010, and growing to 0.35% in 2012. The market cap (i.e. index weight) is well above that at 0.58%. Still, unless you are an index fund, avoiding this sector will not put you at major risk of underperforming the overall index.
There will be a time for those with a strong contrarian streak to own this sector, I just don’t think the time is now. Wait until the sector starts to be among the leaders in terms of estimate revisions, then pounce on it. You might not get the low tick, but there should be plenty of room to ride it when this sector does finally get its act together.
iShares US Home Construction ETF: (ITB - ETF report).
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