Halfway through the third quarter earnings season, and there are two key catalysts:
- The demand is strong.
- Cost inflation and supply chain issues are the main headwinds, but businesses are learning to cope with them.
In some cases, the disruption in the supply chain has taken a serious toll. Apple CEO Tim Cook said supply chain problems cost the company $ 6 billion due to chip shortages and COVID-related production disruptions in Southeast Asia.
The main topics discussed among investors watching earnings: Are supply chain problems and cost inflation peaking, and how long can American companies keep raising prices?
Income: the good, the bad, and the ugly
So far, there’s a lot to like about the income. The bright spots:
Demand is strong in almost all industries.
Here is Hershey’s CEO Michele Buck: “We’re raising both sales and earnings guidance for 2021 to reflect increased consumer demand in all markets, improved tax prospects and optimized brand investments that, taken together, are likely to more than offset higher supply chain costs and inflation. “
It’s the same story at 3M that’s being watched closely because it’s sold in many industries (industrial, transportation, electronics, healthcare, office supplies) and among the most geographically diverse industries (less than half of US sales ).
Mike Roman, CEO of MMM, summed up the quarter for the majority of American businesses when he said, “End market demand remains strong and we have handled supply chain disruptions.”
The September report by the Institute for Supply Management found that the mood among manufacturers was “optimistic” due to the high demand for goods: incoming orders rose, inventories remained at a low level and the order backlog remained “at a very high level” .
The profit margins are lower but not dramatic.
Operating profit margins reached all-time highs in the second quarter: 13.5%. The second highest profit margins ever recorded were recorded in the previous (first) quarter at 13.0%.
Currently, the mixed profit margins for the S&P 500 are 12.5% for the third quarter.
“That’s a lower number than the previous quarter, but it’s still close to historic highs,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
The following is worrying about revenue
Profit growth remains strong, but nowhere near as strong as in the first half of the year. Fewer companies beat estimates, and most importantly, they don’t beat as far as they did in the first half of the year.
The companies reported so far, for example, have exceeded analyst estimates by around 10%. This is above the historical norm of around 5%, but well below the around 20% of the first and second quarters.
Even more worrying is the fact that estimates for the quarter we are in now – the fourth quarter – will not be revved nearly as much as in previous quarters.
The earnings estimate for the fourth quarter is now according to Refinitiv at 22.9%. That’s still healthy, but not much above the 21.7% analysts were expecting a month ago.
In the first and second quarters, the analysts increased their estimates much more aggressively due to the strong growth in demand in the previous quarter. While demand remains strong, analysts are not increasing their estimates as aggressively as they were at the beginning of the year.
This suggests that Corporate America isn’t nearly as surprising to analysts as it was in the first half of the year, when many on Wall Street were surprised by the strength of the economic recovery.
This is where discussion is going on
Three issues are discussed on Wall Street: how long can companies keep raising prices, when will the supply chain / labor issues subside, and is the technology a specific problem?
How long can companies raise prices?
S&P profit margins of 13% and more are well above the historical average, which has been 8.1% since 1993, according to the S&P Dow Jones Indices. S & P’s profit margins started rising over 10% in 2017. What drove you up?
Think of profit margins as profit divided by sales. The main factor behind the increase in margins: profit grew faster than sales.
Revenues have increased, but since costs have not increased that much, those higher revenues have gone straight to the bottom line.
“Sales have increased because both sales and prices have increased,” said Silverblatt. “Companies have both. Sales go up, but companies also raise prices.”
There is a limit to how far this game can go, he tells me: “These high margins cannot last because at some point you will face higher prices and have to invest more in the company.”
At the moment, higher prices face little resistance. For example, MMM’s CFO Monish Patolalawala noted that margins were 20% versus an expected range of 19-20% and that the company continued to raise prices.
Sherwin Williams reported similar issues, although their margins deteriorated due to higher raw material costs and difficulties in sourcing those raw materials, resulting in lower sales.
Still, CEO John G. Morikis said margins would rebound: “We continue to implement price increases to offset higher raw material costs across the company and are confident that margins will rebound when headwinds to inflation finally ease. “
When you put it all together, the American company convinced Wall Street that margin erosion will be modest or that it will recover in 2022.
“In our opinion, many investors expect supply chain disruptions and inflation to be temporary. Or at least its impact will be less severe than expected, ”Earnings Scout’s Nick Raich said in a note to customers. Raich noted that estimates for 2022 had started to rise, which he believes is an early sign of the supply chain and that inflation worries could ease.
Will the fourth quarter be the peak of supply chain and labor worries?
The supply chain problem encompasses several issues including a semiconductor shortage, higher raw material costs, a shortage of labor and congestion in ports.
Each of these problems is interrelated but independent and can have its own schedule for resolution.
Goldman Sachs’ Jan Hatzius believes a major supply chain problem – a semiconductor shortage – will improve this quarter as many factories restart next year and others expand capacity next year.
This was supported by Ford, which said in its press release, “Semiconductor availability remains challenging but has improved significantly over the second quarter, driving sequential increases in wholesale shipments and sales of 32% and 33%, respectively.”
In terms of labor shortages, the phasing out of emergency unemployment insurance in September should also bring more people back to work this quarter, Hatzius said in a statement to customers.
A third problem – congestion in US ports – can last longer. Hatzius assumes that the traffic jams can only be completely eliminated in the second half of 2022.
“This slower resolution of supply bottlenecks means that year-on-year inflation will be higher than we previously expected immediately after the throttling,” said Hatzius.
Andrew Obin of Bank of America Securities examined data from the ISM Manufacturing Index and concluded that while there are still significant delays in delivery, they may have peaked: “The number of respondents who saw increases in lead times and Seeing commodity prices is well above historical norms, we see reasons for optimism, considering that these indices have fallen since peaking in May. “
Apple’s Tim Cook also noted that these were separate issues. “COVID-related production disruptions have improved a lot,” Cook told CNBC’s Josh Lipton. “The chip shortage continues.”
Is technology a problem?
Many big tech names have disappointed this reporting season: including Apple, Amazon, IBM, Intel, and SNAP. Others haven’t: Alphabet, Microsoft, and Shopify all reported strong numbers.
At the core of most of the disappointment, however, remained supply chain issues that are likely to subside, as Webush analyst Dan Ives said in a note immediately following Apple’s profits: “It’s not a demand problem, but a supply problem that continues to be the elephant in the room for Apple and all other tech / consumer players heading into the holiday season … we consider this to be temporary and in no way detracts from our long-term optimistic view. “
