Earnings Season In Review: Who's Winning?

On Monday, the third quarter earnings season will officially close out, with H & R Block Inc HRB as the final S&P 500 company to report. The season is ending with impressive earnings growth of 11.7 percent, paired with revenue growth of 4.8 percent, proving that companies are still closely managing costs and using share buybacks to get a pop on the bottom-line.

Better-than-expected quarterly results were well-received by investors, with the S&P 500 index climbing 5.0 percent from the time third quarter earnings season began on October 8 to yesterday's close.

Standout sectors for profit growth include energy, health care and consumer discretionary. Energy results for the third quarter depict a tale of two growth rates, with the sector exhibiting the highest earnings growth rate of all ten sectors at 14.5 percent, and the lowest sales growth rate of 1.1 percent. This of course is due to the severe drop in oil prices during the quarter, with Brent Crude falling 15 percent from July to October. Such a decline certainly ate into the margins of oil, gas and consumable fuels companies, that industry seeing year-over-year (YoY) revenue growth that was nearly flat at 0.4 percent.

At the company level, Exxon Mobil Corporation XOM typically has the most noticeable impact because it is the second biggest company in the S&P 500 by market capitalization after Apple.

Exxon saw profits increase 6 percent YoY, with revenues falling 4 percent. The fourth quarter is only expected to get worse for oil and gas companies, with both top and bottom-line estimates in the red for the industry at -8.3 percent and -2.4 percent, respectively. The Energy sector as a whole is currently expected to post earnings growth of 1.3 percent and a revenue decline of 6.7 percent for the fourth quarter.

Health Care was a winner again this quarter, with profit growth of 13.9 percent, the second highest of all ten sectors, and the highest revenue growth rate of 12.2 percent. For the second quarter in a row, the sector was driven by the Biotechnology industry, with earnings growth of 45 percent and revenue growth of 39 percent. Notable company performances includes Gilead Sciences, Biogen and Alexion Pharmaceuticals, all posting third quarter profit growth above the 50 percent mark.

Gilead Sciences, Inc. GILD in particular grew a whopping 254 percent on the bottom-line, and 117 percent on the top-line. Results were bolstered by continued progress of the company's Hep C drug, Slovaldi, which saw sales of $2.8B. In October, the company introduced Harvoni - a single tablet regimen for the treatment of Hepatitis C, expected to follow in the footsteps of Slovaldi's success.

Contributors on the Estimize platform anticipate the company will post earnings per share of $2.33 in the fourth quarter in comparison to Wall Street's estimate of $2.21. If the company does come in with $2.33 a share, it would represent YoY growth of 348 percent, while the current revenue consensus of $6.85B would indicate growth of 120 percent. Strong Q4 expectations have the overall health care earnings and revenue growth rates currently seated at 54 percent and 36 percent, respectively.  

Third quarter results for the consumer discretionary sector continued to point to signs of a healthy U.S. consumer. Earnings growth settled at 13.6 percent with only PVH Corp and Dollar General left to report from that sector.  Strength once again stemmed from the retailers, specifically the internet retailers which were up 25 percent YoY, with specialty retail and textiles, apparel and luxury goods not far behind, both at 11 percent. Big wins from the likes of Michael Kors, L Brands, Best Buy and Netflix were contrasted by steep losses from Amazon, Coach, Urban Outfitters, and Kohl's.

This past weekend, with Black Friday kicking off the holiday shopping season, we got a sneak peek at what's ahead for retailers in the fourth quarter. While the headline number from the National Retail Federation showed an 11 percent drop in sales, the sense is that the decline is due to a combination of the move towards online shopping and an extended discount period which will distribute sales throughout the month, rather than just having them concentrated on Black Friday weekend. For the fourth quarter, the consumer discretionary sector is expected to show a 13% increase in profits,  with internet retailers up 16.8 percent, multi-line up 9.8 percent, specialty up 11.8 percent and textiles, apparel and luxury goods up 12.1 percent.

On the flipside, the defensive sectors fared poorly this quarter, with telecommunication services showing low growth of 1.4 percent and utilities at 2.6 percent.  Of the five companies within the telecom sector, only Verizon Communications showed YoY profit growth of 15.6 percent. Within utilities, the gas utilities industry was the main culprit of lower earnings, declining 8.3 percent from the prior year, and revenues falling even further at -12.7 percent. In the fourth quarter telecom is expected to show bottom-line growth of 6.0 percent and top-line growth of 3.9 percent, while utilities is estimated to come in with growth of 2.3 percent and 4.4 percent, respectively.

One interesting stat touted this season was the record high beat rate against the Wall Street consensus. In fact, 74 percent of S&P 500 companies were able to surpass their Wall Street estimate, with a lower amount (60%) beating on the top-line. Is this a sign that U.S. companies are doing a lot better than anyone anticipated? Or is this just another example of the “earnings game” in which companies purposely low-ball their guidance knowing that it will ultimately be included in sell-side estimates? The Estimize findings suggest the latter, and reinforce the fact that this practice of issuing conservative guidance in order to beat and get a pop in the stock price is alive and well. Only 56 percent of S&P 500 companies beat the Estimize consensus, with 53 percent beating on revenues.

The main concerns from S&P 500 companies this quarter were around weakness in Europe and the strengthening dollar. Approximately 20 percent of reporting companies mentioned either or both as an area they were watching. With respects to Europe, large multinational companies such as Coca-Cola, General Electric and Johnson & Johnson all admitted that a weaker economy in Europe was having a negative impact. The stronger dollar seemed like a more widespread concern, however, with many companies calculating the impact continued strength would have on fourth quarter sales and profits. For example, McDonald's expects a Q4 negative impact of $0.05 - $0.06 and Nike says their revenue growth outlook is one or two points lower on account of the stronger dollar. While that hasn't seemed to subside, the hope is that recent central bank actions in Europe will help that region recover, which would be a welcomed change as nearly 10% of all S&P 500 sales come from Europe.

Just as quickly as the third quarter ends, a new quarter begins. Autozone will be the first S&P 500 company to report for the fourth quarter next Tuesday, December 9. Of course, the unofficial start to the season doesn't come until Alcoa reports on January 12. The Estimize consensus is currently calling for Q4 earnings growth of 8.6 percent and revenue growth of 3.5 percent with energy being the only sector expecting negative numbers for each. Strength is expected to come from some of the usual suspects, health care at 18.5 percent and consumer discretionary at 13 percent.