Earnings Season Finds Companies Bullish in Face of Supply Bottlenecks
- By John Tierney
- 4 min read
Summary
- A review of 3Q earnings shows Corporate America is still posting earning beats near 10% in 2021 – far above the normal 2% or so.
- In part analysts and companies alike are having difficulty gauging near-term trends in the Covid economy.
- But companies are also adapting rapidly to resurgent demand – and have been fed the bottom line by passing on rising costs.
- Companies seem confident these trends will continue. There is little concern about potential risks, such as sustained higher oil prices, port bottlenecks or inflation and a hawkish Fed.
Investment Implications
- If they are right, equity indices should continue to rally. But even if conditions worsen, expect companies to be nimble, which could limit downside risks.
You might think Corporate America should be having a rough 3Q 2021 earnings season. After all, look at the ongoing headlines about supply bottlenecks and shortages of labour, key materials and inputs. And there was also the scourge of a resurging Covid (Chart 1).
But you would be wrong – and not just because earnings and sales beats are extraordinarily high by historical standards (Chart 2).
In pre-Covid times average earnings beats were 2-4% and sales beats around 1%. In 2021, earnings beats have been running near 10% and sales beats around 2%. At one level, you can dismiss this as a result of gullible analysts too focused on company projections – although, in fairness, many companies have struggled to scope out even near-term business trends in the past year.
Earnings Beats Reveal Pricing Power
But there is meat behind the earnings beats too. Here are some general observations based on the earnings reports to date:
- The economy and economic activity returned more strongly than many expected despite the Delta variant causing rising infections. People returning to offices, schools reopening, families hitting the roads for vacations, and patients getting long-postponed elective surgeries all boosted economic activity and demand.
- Many companies face bottlenecks and shortages but seem to have been highly creative in working around them. Larger companies have relied on backup factories and sourced raw materials from other suppliers. Smaller companies have substituted other materials for what they normally use.
- Many companies so far have been able to pass on higher costs or have capitalized on tight supplies and strong demand to raise prices.
Looking at specific sectors:
- Big Pharma – Has benefited from strong sales of diagnostic tests, especially for Covid. Companies that make medical devices have seen stronger demand due to more elective surgeries in areas not overwhelmed by Delta. And there has been strong demand for consumer goods.
- Airlines – Demand is rising for air travel by businesses and recreational travellers. Most airlines are forecasting robust growth in air travel during the holiday season and in 2022 now international travel is opening. An offsetting factor is rising jet fuel prices, from around $2/gallon to $2.25-2.40, but airlines believe demand will be strong enough that they can pass on some or much of this cost.
- Railroads – Volumes of many goods are down due to bottlenecks at ports and destinations requiring trucks for final delivery. But demand for rail services is strong, and railroads have been able to raise prices. Tighter energy supplies have also increased demand for shipping coal by rail.
- Regional Banks – Most of them posted good earnings largely due to fee income on mortgages and Paycheck Protection Program loans and because they were able to release loan loss reserves added when the pandemic started in 1H 2020. To the extent they have seen loan growth, it has been in the consumer sector. Commercial lending has been flat, but they expect middle market lending to rise in coming months.
- Energy – Producers are benefiting from higher prices for oil, gas and coal.
There Is Underlying Confidence…
Most companies expect demand for their goods and services to remain strong. And they think they can satisfy later the demand they cannot meet now. This implies the demand recovery may be drawn out and sustainable.
…and Little Mention of Risks
Little exists by way of warnings about the potential adverse impact of higher energy prices, escalating port bottlenecks, inflation, or tighter monetary policy. Companies don’t seem concerned consumers will baulk at higher prices, leaving them to eat higher costs.
At this point, about half of S&P 500 companies have reported 3Q earnings. We are accumulating new information by the week about higher energy prices, supply bottlenecks, labour shortages and more. Some companies may turn more cautious about 4Q and beyond earnings in coming weeks.
But for now, Corporate America seems to be in a Goldilocks world. It thinks it can cope with the prevailing issues and still make money. If it succeeds, equity indices should maintain upward momentum. But even if the bubble bursts, do not be surprised if companies adjust quickly. 3Q earning reports imply the current challenges are forcing them to be nimble.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.