Earnings season: The good, the bad, and the very ugly
With the world economy already in a recession, investors are scrambling to figure out how deep this slump will be and how long it will last. In a sense, this is what this earnings season will be about. ‘Beat’ or ‘miss’ on earnings might not matter much, as almost every business has been impacted severely by the lockdowns.
What will matter though, is the guidance and commentary by management teams. How are their future orders shaping up, and how quick of a recovery in their earnings do they foresee once economies reopen? If the economy’s re-opening is delayed, how big of an impact might that have on future earnings? Are they cutting costs and laying off workers to cope, or are the government’s rescue measures enough?
The collective answer to all these questions could determine whether the recent recovery in stock markets will last, or whether equities have run too far too fast, and will now turn lower again.
Beyond that, this earnings season will also reveal a ‘two speed’ market. Some companies and sectors have been hit especially hard by the virus-fighting lockdowns, some others only a little, while some have even benefited from the whole thing. Let’s take a look.The good
In this crisis, the biggest winners are firms that profit from consumers staying at home. A good example would be gaming companies, with stocks like Electronic Arts and Activision Blizzard trading higher year-to-date.
Or take telecommunications companies such as Verizon, whose CEO recently pointed out that daily phone calls have more than doubled and the duration of those calls is longer than previously. It turns out that when Americans are stuck at home, they call each other a lot.
Netflix is another great example. If you are going to spend the next month or so isolated, there’s suddenly a lot of spare time for watching series, and the spike in interest for ‘Netflix’ on Google trends reflects as much. Indeed, the firm’s stock is back near its all-time highs.
Microsoft is on this list too. With millions of people working from home, cloud computing services have never looked more attractive. A balance sheet that’s flush with cash helps as well.
But perhaps the biggest winners are large online retailers. While the economic shutdown has inflicted untold damage on smaller retailers and department store chains like Macy’s or Kohl’s, it has done wonders for giants like Amazon and Walmart, both of which have seen their stock hit new records lately. With so many smaller players now facing bankruptcy risks, both companies are in a very strong position to expand their dominance in the retail sector. Amazon’s cloud business is booming too.The (not so) bad
This category fits companies that have been impacted by the pandemic, but not dramatically. Sectors such as semiconductors, energy, and industrials could suffer in the short term, but many companies with good long-term growth potential, strong management, and healthy balance sheets are also becoming attractive.
Take Nvidia for instance. Although the chipmaker’s stock initially dropped, the company’s close links to a gaming industry that is booming and a balance sheet without much debt on it, put it in a good position to weather this storm. A similar story is true for competitor AMD, though that company is trading at a richer valuation and is also more indebted.
Or take energy giants like Exxon Mobil and Chevron. While the broader US energy industry is crashing as the plunge in oil prices has turned most shale oil producers into loss-makers, these firms stand to take advantage. The oil sector will likely see waves of defaults soon, and the bigger players will be there to buy the assets of any insolvent companies at a huge discount, increasing their market share and putting them at a competitive advantage in the longer term.
Pfizer is worth a mention too. Surprisingly, the drugmaker has been impacted by this health crisis, as a big merger it had planned has been delayed. However, that merger is still scheduled to go through, and the company is also at the forefront of efforts to develop a coronavirus vaccine. Although that’s true for other pharma giants like Johnson & Johnson, Pfizer’s valuation is much more attractive at 12x estimated forward earnings, compared to J&J’s 17x.
Disney is another example. The company’s stock is still down almost 30% this year, as there’s no clear timeline on when its theme parks will re-open or when its films will air in theaters again. Even after the lockdowns end, it may take a while until people feel comfortable in crowded places again. Yet, the company also has a streaming service that’s growing extremely quickly, helping to blunt the pain.The very ugly
Here we’ll examine industries and companies that have been annihilated by the pandemic, and whose future doesn’t seem very bright. These are super-high-risk but also high-potential-reward plays, meaning that some of these companies might face bankruptcy, but the ones that survive could ultimately see their shares recover substantially from very depressed levels. They include airlines, cruise lines, department stores, smaller oil producers, casinos, and restaurant chains.
Let’s start with cruise lines. Norwegian Cruise Holdings, Carnival, and Royal Caribbean Cruises are the worst-performing stocks on the S&P 500 this year, down 80%, 77%, and 75% respectively. Their revenues have evaporated, and nobody knows when cruises will resume or how much demand there will be for them. Worst of all, the government’s rescue package doesn’t protect cruise liners.
The airline industry isn’t doing much better. United Airlines’ stock is down 67% year-to-date, while Delta and American Airlines are roughly 60% lower. While those losses are warranted considering how long it will take before planes fly normally again, the important distinction is that airlines will get significant government support, so the default risk of these companies is much lower compared to cruise liners.
Next are ‘smaller’ oil producers like Noble Energy and Marathon Oil, who are down 70% and 67% accordingly this year. Apache Corp (-67%), Occidental Petroleum (-62%) and Devon Energy (-62%) also fit this list. All these names have been devastated by the plunge in oil prices, and judging by their stocks, markets have priced a real default premium. Apache Corp and Occidental in particular seem to have the weakest balance sheets, as they’ve taken on a lot of debt already.
Finally, an honorary mention for Boeing, which is down 55% year-to-date. The jet maker faced serious problems before this pandemic, namely its 737 MAX scandal, and the decimation of the airline industry only amplified those troubles. However, Boeing is a unique case. As the biggest US plane maker and a major national employer, Boeing is simply ‘too big to fail’. While it may take a long time to regain its former glory, it won’t be allowed to go bankrupt either given its importance to “national security”.The bottom line
All told, picking winners and losers in a crisis is a tricky exercise. The companies that are making a killing today due to the lockdowns might not do so well once the crisis blows over and people start going out again, even if that takes time.
Therefore, for investors with a long time horizon, real value could lie with high-quality names that have taken a hit, but have strong long-term growth prospects and clean balance sheets to ride out this crisis. For investors with a greater tolerance to risk, the most beaten-down names might also be interesting, as any improvement in the virus saga could trigger epic rebounds.That said, we are still in the early days of a recession, so caution is warranted.
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