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Plenty of Positive Retail Surprises

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Note: The following is an excerpt from this week’sEarnings Trends report. You can access the full report that contains detailed historical actual and estimates for the current and following periods, please click here>>>

Here are the key points:

•    The Retail sector’s Q3 results show that while earnings growth is hard to come by, results have turned out to be better than expected, with an above historical average proportion of retailers beating estimates.

•    Looking at all the sectors, while Q3 earnings growth is lagging the preceding two quarters’ double-digit growth pace, revenue growth shows steady acceleration.  Earnings growth improves notably once the Finance sector’s drag is excluded from the aggregate picture.  
•    Positive revenue momentum and favorable revisions trend in estimates for the current period are the two standout features of this earning season.  

•    Total earnings for the 470 S&P 500 members that have reported already are up +6.6% from the same period last year on +6% higher revenues, with 72.3% beating EPS estimates and 66.5% beating revenue estimates.

•    Excluding the Finance sector, Q3 earnings growth improves to +10.5% from +6.6%. The Energy sector has the opposite effect, with Q3 earnings growth declining to +4.3% on an ex-Energy basis.   

•    While Finance sector results have been below average, this earnings season is turning out to be a good one for the Energy, Industrial Products, Technology, Construction, Business Services, and Medical sectors.

•    The revisions trend for Q4 estimates continues to be favorable, with earnings estimates holding up a lot better relative to other comparable periods.

•    For full-year 2017, total earnings for the S&P 500 index are expected to be up +7.6% on +4.9% higher revenues, which would follow +0.7% earnings growth on +2.1% higher revenues in 2016. Index earnings are expected to be up +11.7% in 2018 and +9.6% in 2019.
•    Earnings growth is on track to turn positive in Q3 for the small-cap S&P 600 index, with total earnings for the index expected to be up +5.5% from the same period last year on +5.7% higher revenues. This would follow persistent earnings declines for the small-cap index – S&P 600 earnings growth was negative in 3 of the last 4 quarters.

•    Strong growth from the Finance, Technology and Energy sectors are driving the small-cap growth. The Finance sector’s role is particularly notable in the small-cap index, with Q3 earnings growth rising to +6.7% (from +5.5%) on an ex-Finance basis.

The market is applauding Wal-Mart’s (WMT - Free Report) Q3 earnings report for the reassurance these results provide about the company’s ability to effectively compete with Amazon (AMZN - Free Report) in the current shifting retail environment where many of its brick-and-mortar peers have struggled. Amazon has always been growth and market share, never making margins and profitability a priority.

Importantly, Amazon has successfully conditioned market participants to not judge it negatively for this lack of earnings and margins. The challenge for Wal-Mart and other retailers faced with the Amazon challenge is that they will likely have to forego near-term profits as well to effectively compete. The Wal-Mart report shows aspects of this reality – the retail giant’s Q3 report showed plenty of growth attributes, but those additional sales dollars didn’t have the same margins. In other words, the while Wal-Mart’s Q3 top-line increased +4.2% from the same period last year, net income was down -1.1%.

It is this lack of earnings power that will likely be the enduring Amazon effect on the broader retail sector. Retailers will need to forego near-term profits to hold their ground in this new Retail landscape.

The charts below compare the Zacks Retail sector’s Q3 results with what we have seen the same group of retailers in other recent periods.

What this shows is that total earnings for the Retail sector companies that have reported are up +1.9% on +7.4% higher revenues, with 75.9% beating EPS estimates and 62.1% beating revenue estimates.

As you can see, except for earnings growth, the sector’s Q3 showing is an improvement over what these same retailers reported in other recent periods. The very strong +7.4% revenue growth in Q3 for the sector is thanks in no small measure to the +33.7% higher Q3 revenues for Amazon. Excluding Amazon, the sector’s Q3 revenue growth drops to +4.9% (from +7.4%), but the +4.9% revenue growth pace is still an improvement over the same ex-Amazon group of retailers in other recent periods.

Q3 Scorecard (as of November 16th, 2017)

We now have Q3 results from 470 S&P 500 members that combined account for 96.2% of the index’s total market capitalization. Total earnings for these 470 index members are up +6.6% from the same period last year on +6% higher revenues, with 72.3% beating EPS estimates and 66.5% beating revenue estimates.

The charts below compare the results thus far with what we have seen from the same group of 470 index members in other recent periods.

What these comparison charts shows are:

•    The earnings growth rate (+6.6%) for these 470 index members is lower than what we saw from the same group of companies in Q2 and is also below the 4-quarter average. The earnings growth comparison improves on an ex-Finance basis.  
•    The Q3 revenue growth rate (+6%) represents an acceleration from all other periods in the chart.
•    The proportion of positive EPS beasts (72.3%) is a shade below what we saw from the same group of companies in the preceding quarter, but broadly in line with the comparable periods in the chart above.   
•    Revenue beats is slightly below the preceding quarter, which itself was an unusually high revenue beat rate relative to historical periods.

While overall Q3 earnings growth represents a deceleration from the double-digit growth pace of the last two quarters, the growth rate is expected to ramp up in the current and coming quarters, with Q4 earnings growth currently expected at +8.7%.

Importantly, estimates for Q4 have held up very nicely since Q3 results started coming out, as the chart below shows.

This revisions trend is the most notable positive development on the estimate revisions front in recent years. Q4 estimates for 9 of the 16 Zacks sectors have come down since the start of the quarter, with estimates for the remaining 7 sectors going up. The strongest gains have been in the Energy, Industrial Products, Basic Materials and Technology sectors. The positive Energy sector earnings revisions reflect developments in oil prices, which have started showing in EPS estimates for ExxonMobil (XOM - Free Report) , Chevron (CVX - Free Report) and others.  

The chart below contrasts the Q3 earnings growth rate with what was actually achieved in the last 5 quarters and what is expected in the coming four periods.

Unlike the year-over-year growth pace, the dollar amount of total earnings is on track to reach a new all-time quarterly record, as the chart below shows.

Please note that the June quarter tally in the chart above was a new all-time quarterly record for the S&P 500 index. But the record isn’t expected to last much longer, with each of the next two quarterly tallies surpassing the preceding period’s record.

Note: Sheraz Mian manages the Zacks equity research department. He is an acknowledged earnings expert whose commentaries and analyses appear on and in the print and electronic media. His weekly earnings related articles include Earnings Trends and Earnings Preview. He manages the Zacks Top 10 and Focus List portfolios and writes the Weekly Market Analysis article for Zacks Premium subscribers.

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