Q2 Earnings Too Close to Call

07/16/2012 10:00 am EST

Focus: MARKETS

CHAD FRASER

, MPL COMMUNICATIONS INC

If quarterly earnings were ever obsessed over, now is certainly the time, and this quarter’s numbers are shrouded in mystery, writes Chad Fraser of Investing Daily.

The second-quarter earnings season unofficially kicked off last Monday, with Alcoa (AA) playing its traditional role of being the first company out of the gate. The aluminum giant reported its latest results right after the closing bell.

The company’s numbers will set the tone for the second-quarter earnings season. Here’s how they looked: In its latest quarter, Alcoa’s sales fell 9.4%, to $5.96 billion from $6.59 billion a year ago. The company lost $2 million, or broke even on a per-share basis. That’s down sharply from a profit of $322 million, or 28 cents a share, a year ago.

However, if you exclude a large number of unusual items, such as restructuring costs and $45 million to settle a civil lawsuit, earnings came in at $6 million, or 6 cents a share. On that basis, they beat the 5 cents a share that the Street was expecting.

Aluminum prices have fallen 18% from a year ago, and global production continues to exceed demand, as it has for the past eight years.

Alcoa’s Report Is Still a Positive
Even so, the company reported slightly higher aluminum shipments, thanks in part to higher demand from the aerospace and automobile industries. Car sales are expected to climb 11% this year, and aircraft manufacturers have record order backlogs as airlines replace their old planes with new, more fuel-efficient models.

Alcoa stood by its prediction of an aluminum supply deficit in 2012, largely due to production cuts in China. The company also affirmed its forecast of a 7% rise in aluminum demand during the year.

“In their downstream business and midstream business, those two pieces, we are seeing margin expansion,” Citigroup analyst Brian Yu told Bloomberg Businessweek. “It’s a sign that, yes, the company is doing some things right.”

Why Many Analysts Are Pessimistic
Despite Alcoa’s earnings beat, most analysts are downcast about the coming earnings season. Here are three main reasons why:

  • Reduced guidance from many S&P 500 companies.

According to Reuters, more than 85 members of the S&P 500 have recently lowered their earnings guidance, including Procter & Gamble (PG), which feels its sales dipped 1% to 2% in the quarter ended June 30. Ford Motor Company (F) has also said that it expects to report higher losses at its businesses outside North America.

On the surface, expectations still look strong: overall earnings are expected to rise 5.8% from a year ago. But if you strip out Bank of America (BAC), which is expected to show a huge profit increase due to the settlement of a mortgage-related lawsuit, and Apple (AAPL), that number drops into negative territory: a decline of 0.4%.

A further challenge is the tough year-over-year comparison: in the second quarter of 2011, S&P 500 companies posted profit growth of more than 19%, according to USA Today.

  • Europe’s ongoing woes—and a slowdown in China.

According to CBS Moneywatch, about 14% of all S&P 500 company sales come from Europe, so the continent is bound to be a dominant theme as earnings season plays out.

In addition, growth is cooling in China, the world’s third-biggest economy. The country’s economy likely expanded 7.6% in the quarter ended June 30, but that’s still down from a year ago, and would mark China’s sixth straight quarter of slower growth.

“It’s natural to expect that somehow the US corporate sector, which has been a bright spot in this recovery, is not going to emerge unscathed,” said Brian Gendreau, a market strategist with Cetera Financial Group.

  • Continued weakness in the US.

Friday’s labor department numbers showed that 80,000 jobs were created in the US in June, well below the 100,000 positions that analysts were expecting. That added to worries about another recession and darkened the mood heading into earnings season.

“Buying stocks and hiring people are both things you do when you want to take risks,” said Jerry Webman, chief economist at Oppenheimer Funds, in a MarketWatch article. Right now, he says, the current uncertainty is keeping “investors and employers from wanting to take additional risk.”

Low Expectations Could Actually Spark a Rally
Despite the significant challenges ahead, there are a number of reasons why stocks could still rally in the coming months. The main one is the low earnings expectations themselves.

As The Wall Street Journal points out: “The big caveat, of course, is companies have gotten pretty good at setting low expectations. That enables them to leap over the lowered expectations bar and earn a coveted upside earnings surprise, which the market tends to cheer. Stocks could pop even if year-over-year earnings numbers don’t look so hot.”

Another interesting angle to watch will be the effect of lower oil prices on corporate bottom lines. According to Forbes, oil prices are down 12% from a year ago, and prices for many other commodities have also fallen. That obviously hurts commodity producers, but it should help consumers, including manufacturers, consumer-product makers and, most obviously, shipping companies.

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