Market Insights April 29, 2011
“Do not accept your dog’s admiration as conclusive evidence that you are wonderful” — Ann Landers
O.K., I won’t let my dogs’ wagging tails and slobbering mouths inflate my ego but…….I will get excited about the 1st quarter corporate earnings reports, they ARE wonderful so far. Although there has been persistent chatter lately about sub-par (+2.0% to +2.5%) GDP growth in the 1st quarter of 2011 (the preliminary number announced today was actually + 1.8%), corporate America is telling us that they are on solid financial ground and making profits in spite of a 1st quarter slow-down in GDP . Gross margins apparently are not yet feeling the squeeze from higher oil prices and rising commodity costs. Consider some of the reports from U.S. companies over the past two weeks (all figures are year over year comparisons):
TECHNOLOGY —- Microsoft – revenues +20% and profits +35.5%; Netflix – revenues + 46% and profits doubled; Ebay – revenues +16.1% and profits +12.7%; Apple – revenues +83% and profits +95%; Google – revenues +27.8% and profits +18.1%; Intel – revenues +24.5% and profits + 37%.
CONSUMER DISCRETIONARY —- Chipotle – revenues +24.3% and profits +22.6%; Panera Bread – revenues + 16.2% and profits +33.4%; Travelzoo – revenues +30% and profits + 144%; Starbucks – revenues +10% ($2.8 billion in sales is largest quarter in corporate history) and profits +13.5%; Ford Motor – revenues +14.9% and profits + 11.8%; Stanley Black & Decker – revenues + 89% and profits +11.5%; Colgate Palmolive – revenues +4.5% and profits + 61.8%.
INDUSTRIALS and CAPITAL GOODS —- Caterpillar – revenues + 52.3% and profits + 403% (that’s right, 403%….no misprint); U.S. Steel – revenues +14.2% and profits TRIPLED; Alcoa – revenue +43.6% and profits + 33.5%; Peabody Coal – revenues + 18.6% and profits + 17.2%; General Electric – revenues + 6.6% and profits + 81% (every segment of their business showed growth and they raised the dividend for the 3rd time in 9 months); DuPont – revenues +18.2% and profits +27.1%; Honeywell – revenues +15% and profits + 40.2%; Schlumberger – revenues +56.3% and profits + 40.7%; Corning Inc. – revenues + 25% and profits +20.9%; Dow Chemical – revenues + 10.3% and profits +34.5%; Norfolk Southern – revenues + 17.% and profits +26.8%.
I could go on and list at least another 72 companies that have reported double digit revenue and profit growth for the 1st quarter and we are only half way through the current reporting period. Earnings are that good. Jim Cramer (host of CNBC’s Mad Money), shines more light on what is happening in corporate America when he says, “Sometimes we have to go under the radar screen of the big-capitalization companies to understand the pulse of what’s going on in the country and today, you must listen to a little $ 2 billion company, Carpenter Technology, or CarTech as it is known around its Reading, Pa. headquarters. Carpenter Technology was known primarily as a steel company for years and years. It now makes a bunch of alloys that go into pretty much everything that can be manufactured in this country. Which is why I took notice when they reeled off how those businesses were doing during the earnings conference call. To wit: Aerospace: +30% this year over last year, driven by growing demand for engine components and titanium airframes. Industrial: +42% this year over last year, driven by demand so strong that price increases stuck. Energy: +132% this year over last year, driven by demand for industrial gas turbines and oil and gas applications. Consumer: +26% this year over last year, driven by higher-value alloys used in sporting goods (golf clubs and shot guns). Automotive: +34% this year over last year, driven by higher demand for turbo-chargers. International: +35% this year over last year, ($142 million in sales and 40% of that from Europe) driven by aerospace, automotive and energy. Demand is so good that the company announced on the call that it is spending between $150 and $200 million to expand manufacturing.”
The surge in corporate profits has its more recent origins, in the collapse of the economy in 2008 and early 2009. The evaporation of demand and available credit during that 5 month period occurred with such speed that even the strongest of companies found themselves with no access to capital for nearly a month, an eternity for a CFO. Unemployment sky-rocketed, interest rates and stock prices plummeted as a result of the near failure of the global financial system. The Great Recession had left a mark on not only you and I but also on CEO’s, CFO’s, creditors and shareholders. Because of these painful memories, several things have happened in corporate America as the economy has recovered. First of all, productivity has risen dramatically as companies are doing more with fewer workers. Managers are still reluctant to commit to bigger payrolls and the benefits that come with those jobs. Technology has replaced some of these workers but more accurately, managers and CEOs have no intention of aggressively hiring again until they are reasonably certain that the horrible period of 2008-2009 is in the rear view mirror. This is why the unemployment rate has fallen only 1.3% despite two consecutive years of GDP growth. Second, the Darwinian nature of capitalism allowed the stronger, better capitalized companies to take market share during the Great Recession. They either stepped into markets when competitors failed or they simple acquired weaker companies that had previously been in their way. After digesting a meal of failed competition, the revenues and profits of the surviving companies have exploded to the upside as the economy has recovered. Third, just as many American homeowners have re-financed their mortgages at the lowest interest rates of a lifetime, so has corporate America. CFOs have been very busy over the last two years retiring (calling in) higher rate debt and replacing it with lower rate and longer maturity bonds. In essence, this is no different than you or I going out and re-financing a 5 year, 6% adjustable rate mortgage with a 3.75%, 30 year fixed rate loan. The short and long term savings to you and I are meaningful, but to a multi-billion dollar company like General Electric or Caterpillar, the impact to the bottom line (earnings per share), is huge. These three simultaneously occurring dynamics are what are behind the profits growth we are seeing today. In 2 short years, corporate America has transformed into a lean and efficient earnings machine that is attracting investment from all over the world. Since earnings ultimately determine stock prices, it no fluke that the DJIA is closing in on 13,000…only a mere 10% from the all-time high.
I remain in the camp of the Bull when it comes to continued earnings growth and higher stock prices for 2011. For nearly 10 years, stocks as an asset class have gone un-loved and distrusted. Times change and now there is no place else to go with the money. Cash yields nearly nothing, real estate is years away from a recovery and banks are reluctant to lend money against it. Treasury bonds are expensive and may ultimately become a higher credit risk than investment grade corporate or municipal bonds. At this point you have to ask yourself, does it make more sense to own high quality U.S. companies that have the capacity to increase already attractive yields of 2.0% to 5.0% and………have profit growth in the double and triple digit range? In the end, as Jim Cramer says, “It is all about amazing margin EXPANSION. That is the big reason why the stock market averages just won’t quit”.
p.s. — While I am optimistic about the stock market and the health of corporate America, I do have a number of things on the radar that concern me and bear watching: the rising cost of energy and agricultural commodities, a change in FED policy, a weak dollar, a stubbornly weak housing market and meaningful legislative progress on the deficit. I will write about these in the next several weeks.
Sources: Real Money (James Cramer), CNBC, Credit Suisse, Dow Jones, Reuters and Bloomberg
Ken Beach, President of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.