More Earnings

By: Chad Hudson | Thu, Apr 24, 2003
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(UNEDITED)

Earnings reports continue to poor in and at first glance, earnings appear to be okay. Earnings are nothing spectacular and the quality is a little questionable, but better than analysts were forecasting. Granted, estimates were low and actual earnings growth is as well, but the market cares about beating the bogy and companies are doing that. Earnings quality questions the sustainability of earnings growth. Earnings growth is coming from cutting cost and not through sales growth. Plus, a significant amount of revenue growth is due to translation of foreign sales due to a weak dollar. The dollar is down around 15% from the year ago period, which means foreign sales are now translated back to more dollars. This benefit is accounting for up to half of the revenue growth for multi-nationals. Last week, IBM said it would not give guidance for the second quarter, but maintained its full year guidance. Since then there have been several that have either not given guidance for the second quarter or reduced guidance for the second quarter, but held full year guidance.

The homebuilders have been reporting stellar results, and have to be best performing area of the economy. The companies do not see the strength abating soon. At D.R. Horton sales grew 33% from last year, closings were up 19% and backlog increased 32% to an all-time high. In fact, D.R. Horton has either closed or put in backlog 87% of its planned closings for the year. California sales were up 46%, Colorado up 31%, Florida up 43%. The company noted that there was no drop off in sales due to the war. Beazer's sales were 35% better than last year and 92% of its projected closings for the year have either already closed or is in backlog. For the quarter its new orders were up 46%

Interestingly, the strength in the housing market has not transferred over into floor coverings. Mohawk Industries, one of the biggest manufacturers of carpets and other flooring, reported a two percent decline in first quarter revenue after adjusting for acquisitions. Similar to what the manufacturing surveys have indicated, it experienced rising material costs and will be implementing a 5% to 8% price increase this quarter.

Last week, several trucking companies were exceeding analysts' expectations significantly. Arkansas Best didn't live up to the results of its peers; it reported earnings almost half of what analysts were expecting. Nevertheless, its revenues showed strong growth similar to its competitors. Revenues were up 12% helped by shipments per day rising 6.5%, however the company noted in its conference call that, "we are not seeing any strength at all in the economy." It is interesting to note that the company mentioned that its margins were helped by a decline in insurance premiums. When questioned how they have had such good fortune when the other carriers are experiencing large increases, the company answered that they took a larger deductible. This is just one example how cost cutting is one-time in nature and will pose problems for future earnings growth if sales stagnate.

Praxair, the largest industrial gas company, reported a 9% increase in revenues and a 6% increase when natural gas pass-through and currency affects are excluded. It noted that the energy, health care (+19%), electronics, and metals sectors are showing growth, while chemicals and aerospace are declining. Food and beverage, along with manufacturing were flat. Praxair is another company that is utilizing the favorable credit markets to refinance their debt. Obviously, this is another one-time benefit to earnings as it will be difficult to continually lower interest payments.

Whirlpool grew revenues 5.5% year-over-year. In its conference call, it noted significant increases in pension and employee-related health care costs. U.S revenues and units grew 2%. The company noted that there are significant pricing pressures especially in the lower end of the market. Whirlpool said it is not experiencing the problem Maytag discussed about consumers trading down to lower priced products. Whirlpool did lower its industry outlook for the rest of the year. Instead of the 2% growth in appliance sales, Whirlpool now forecasts sales to be flat with last year. For an indication how much the weak dollar can help revenue growth, Whirlpool had European sales increase 19% in dollar terms, but sales actually declined 1% in local currencies.

Lexmark, one of the leading printer manufacturers, actually had all of its revenue growth from currency gains. After adjusting for currency translation, its 6% revenue growth actually fell 1%. Favorable currency effects also accounted for about half the 12% increase in operating income. Lexmark noted that IT capital spending remains weak and competition is strong. The consumer market is weak as well, forcing aggressive price competition.

Currency translation also account for half of 3M's revenue growth as well. 3M also noted health care was its strongest segment with electrical and communication showing the only decline.

Hilton's occupancy rate was 70% in the first quarter, most of its weakness occurred in tech-heavy markets like San Jose. Its timeshare business was flat with last year, but average price increased. Hilton also said that rising costs in employee costs (both healthcare and wages) and property tax coupled with the decline in group meetings will shed about 6% of previous EBITDA forecasts for the full year. Hilton is forecasting a healthy summer travel season based on surveys conducted by Travelocity and Travel Industry Association. Anecdotally, Hilton said its call volume has increased since the end of the war. Additionally, about one-third of the canceled group meetings have rescheduled.

Eastman Kodak is another company that currency translation helped turn a decline in revenue to a small gain. Also its business weakened later in the quarter, even after adjusting for Easter falling later this year. Kodak could have significant exposure to SARS. It mentioned that was not an issue in the first quarter but will be in the second, but to what degree is difficult to predict.

Moody's said investors' became more comfortable holding speculative issues. Speculative grade issuance outpaced last years, whereas investment grade issues lagged the year ago period. Moody's also expects the refinancing boom to last a little longer than at the beginning of the year, but it should end this year. The company also expects consumer spending to weaken as well, which will lead to weakness in the ABS market.

For the first time in almost a decade, Harley-Davidson saw a year-over-year decline in U.S. motorcycle sales. Could this be one of the first signs of a slowdown in consumer spending? I'm not sure. Since the fall of Baghdad, it appears that all the worries about the economy and the financial markets have not only been forgotten, but all patched up. Cheap credit cannot fix the problem, but it can certainly delay any corrective action. The market is discounting that the economy is recovering since, first quarter earnings are not good enough to suffice as the reason for the market rally. While there is a decent chance GDP growth can rebound for a quarter or two, there are structural problems in the economy that still need to be worked out. Additionally, I wonder just how long the economy can grow based on financing activity.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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