Why Big Media Earnings May Beat Expectations, While Communications May Struggle

Towers, meanwhile, could see better sentiment coming out of the quarter.

The stock market has moved steadily higher in 2012, with the S&P 500 at its highest level since August 2011. In fact, the S&P 500 is only about 3% below the level from which it plummeted following the downgrade of US debt.

The downgrade proved meaningless, as interest rates on US Treasury bonds, at least partially a sign of the creditworthiness of the US, are well below where they were in the summer in 2011. Following the downgrade, investors expected an imminent recession. As it turns out, late summer represented the nadir for the slowdown in the economic recovery. Almost all data since last fall has been better than expected, and more recently the data indicates a strengthening recovery.

An interesting aspect of recent US economic history has been that large, publicly held corporations have fared well. Corporate earnings did fall swiftly in 2008 and early 2009, but cost cutting, better than feared revenue trends, and maybe most importantly, very sanguine credit conditions, allowed earnings to recover sharply. With another quarterly earnings season about to get under way, corporate profit margins and cash flows are at all-time highs, especially away from the financial sector.

In the second half of 2011, earnings estimates fell sharply. This continued right through year end. The reductions were mostly related to anticipated weakness in the US economy. I suspect that the recent rally is recognition that the analysts overdid it to the downside. Thus, I think you will see better than expected fourth-quarter results and guidance commentary that implies 2012 results are trending above estimates at the moment.

Of course, stock prices reflect expectations, so the setup may not be as good going into earnings as my prior comments imply. The expectations bar has been raised. Looking at media and communications, I think the setup could be decent, particularly in big media.

By all accounts, advertising demand has held up well. We have heard from company managements at a couple of recent conferences. The commentary has been positive. Many stocks in the sector remain significantly below their 2011 highs, further below than the S&P 500. So although there has been a big rally in media stocks this year coincident with the improved investor sentiment toward the economy, there remains room to the upside as long as the guidance supports higher 2012 estimates. I do not expect a lot of analysts to raise estimates coming off the quarterly reports. However, I think that is just because they will want to stay conservative.

The stock prices, not the analyst estimates, will dictate the message. I expect it to be bullish. CBS (CBS) remains my top pick, as it has undeniable business momentum and remains a couple of dollars below its 52-week high. I think CBS is the company most likely to see estimate increases following the quarter.

The outlook for communications is less bullish. The same conferences that saw bullish media commentary injected some caution for communications. The issue is margin pressure in wireless driven by intense competition and smartphone subsidies. In addition, regulatory obstacles to industry consolidation suggest that the competitive landscape is not going to improve. Fairly detailed commentary about subscriber trends likely means little surprise for major wireless communications providers.

One subsector that could see better sentiment coming out of the quarter is towers. Lack of consolidation, smartphone adoption, and intense competition is good for towers. The stocks have been on a tear since the AT&T (T) acquisition of T-Mobile (DTEGY.PK) was denied, so I am not sure the setup is good for the short term into earnings. However, the long term looks as promising as ever, so this is a group to watch, especially to buy on weakness.

Media and communications earnings reports will take a back seat this week as first we hear from big technology companies including Intel (INTC), Microsoft (MSFT), and Google (GOOG). I like Google the best for a play on earnings.

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