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Earnings Outlook

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

The bulk of the Q2 earnings season is now behind us, with results from 474 S&P 500 members already out. Total earnings for these companies are down -3.3% on +0.1% higher revenues relative to the same period last year, with 71.7% beating EPS estimates and 53.8% coming ahead of top-line expectations.

The focus lately has been on the Retail sector, with a number of leading operators like Wal-Mart (WMT - Analyst Report) , Macy’s (M - Analyst Report) , Nordstrom (JWN - Analyst Report) and others coming out with positive surprises and a favorable outlook. These positive reports notwithstanding, the sector’s overall earnings performance is still on the weak side. Driving this weakness has been the steady decline in foot traffic as a result of sales moving online. With many of these operators struggling to deal with this shift in consumer behavior, Amazon (AMZN - Analyst Report) has been able to gain share by offering a compelling user experience.

Amazon’s steady gains in the apparel space is a big reason for the pain in the traditional department store space. The positive results from the likes of Macy’s and others this earnings season is not reflection of a better competitive response to Amazon & Co, but largely a function of factors that will likely not endure beyond the next couple of quarters. These factors include improvement on the inventory front and very low department store expectations. Inventories finally appear to be in-line with sales, which comes after two back-to-back quarters when these operators were saddled with mountains of unsold merchandize as a result of weather and the aforementioned reduced foot traffic issue.

Unlike the department stores, the improvement in Wal-Mart results appear to be more enduring, with the retail giant not only doing a better job at improving its core physical retail operations (cleaner stores, better assortment, and improved customer experience), but also coming out with a credible digital response to the Amazon challenge. Wal-Mart’s online efforts still have a long way to go, but they have been doing a lot more on that front, even prior to the purchase, than most of its peers.

Retail Sector Scorecard

We now have Q2 results from 34 of the 44 retailers in the S&P 500 index that combined account for 91.4% of the sector’s market capitalization in the index. Total earnings for these retailers are up +4.0% from the same period last year on +4.3% higher revenues, with a below index average 55.9% beating EPS estimates and a very low beat ratio of 38.2% coming ahead of revenue estimates.

The side-by-side charts below compare the results thus far with what we have seen from the same group of retailers in the recent past.

As you can see, the earnings and revenues growth rates in the left hand chart are about in-line with historical periods. But the proportion of retailers coming out with positive EPS and revenue surprises in the right hand side chart are tracking significantly below historical periods. In other words, while growth is about in-line with historical periods, but this is weaker than what was expected.

We know that Amazon had a blockbuster earnings report, which is likely giving the growth pace a helping hand. Taking the Amazon results out of the Retail sector results thus far, total earnings for the rest of the space are actually down -0.2% from the same period last year on +2.6% higher revenues.

The charts below show the growth comparison, with and without the Amazon earnings report

This shows that the retail sector’s respectable growth pace at this stage is solely due to the Amazon report. Once we take Amazon out of the sector’s results at this stage (right hand side chart), then the sector’s growth pace turns out be a lot weaker. 

Q2 Earnings Season Scorecard

For Q2 as a whole, we now have results from 474 index members, with total earnings for these companies down -3.3% on +0.1% higher revenues relative to the same period last year.

The side-by-side charts below compare the results from the 474 index members with what we saw from the same group of companies in other recent periods. The left-hand chart compares the earnings and revenue growth rates with historical periods while the right-hand chart is doing the same comparisons for positive EPS and revenue surprises.

Here are the four takeaways from the results thus far:

First, earnings growth remains negative, but is nevertheless an improvement over what we saw from the same group of 474 S&P 500 members in the preceding quarter (2016 Q1) and the 4–quarter average. We may be putting too fine a point by calling a decline of -3.3% as an improvement over a decline of -4.5% (the 4-quarter average), but the Q2 decline is nevertheless an improvement over the preceding quarter.

Second, revenue growth is ever so slightly in the positive (+0.1%) for this group of 474 index members. As is the case with earnings growth for these companies, it is an improvement over what we saw from this group of 474 S&P 500 members in 2016 Q1 and the average for the preceding four quarters.

These earnings and revenue growth comparisons largely remain in place even after we exclude the Energy sector’s substantial drag from the reported results. Total earnings for the Energy sector are down -78.9% on -24.4% lower revenues from the same period last year. Excluding the Energy sector, earnings for the remainder of S&P 500 members that have reported results would be up +0.3% from the same period last year on +3.0% higher revenues.

The comparison charts below show the growth picture with and without the Energy sector. 

Third, positive EPS surprises for the 474 index members that have reported results are tracking modestly above the 4- and 12-quarter averages. This suggests that Q2 estimates may not have been that low after all. Positive revenue surprises, on the other hand, are moderately tracking below other historical periods.

Fourth, estimates for the current period (2016 Q3) have come down, following a well-established historical trend. Total Q3 earnings for the S&P 500 index are currently expected to be down -2.8% from the same period last year, which is a decline from expectations of flat earnings at the start of the quarter.

The chart below shows the evolution of Q3 earnings growth expectations

Please note that while the trend of negative revisions to Q3 estimates is in-line with the recent past, the magnitude of negative revisions is not. In other words, estimates for Q3 are not falling by as much as was the case at the comparable stages in other recent reporting cycles.

Estimates for all 16 sectors have come down since the beginning of July, but they have come down the most for the Auto sector and the least for the Technology sector. The Auto sector weakness is primarily a function of sharp drop in Ford’s (F - Analyst Report) estimates while Technology’s relatively improved estimates revision picture is due to positive momentum for Facebook (FB - Analyst Report) and Alphabet (GOOGL - Analyst Report) offsetting modest declines at other sector players.

Estimates Beyond Q2

The chart below shows (the blended) Q2 growth expectations contrasted with what was actually achieved in the preceding four quarters and estimates for the following four periods. Full-year 2016 earnings growth expectations have now turned negative, similar to what we saw last year.

Beyond the current period (September quarter), meaningful growth is expected to resume from Q4, which is then expected to continue into 2017. Easier comparisons for the Energy sector arrive in Q4, when the sector’s earnings growth turns positive. But the expected growth in Q4 and beyond isn’t solely a function of easy comparisons for the Energy sector – the expectation is for positive momentum from a broad cross section of sectors. Those expectations will most likely need to come down. But it will be interesting to see to what extent they will have to come down.

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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