Capital Markets

Earnings Forecasts: Gathering Clouds

An analyst predicts a ''tsunami'' of downward revisions in cyclical stocks. Reasons for gloom also include high raw-material costs and flagging con...
Stephen TaubSeptember 29, 2004

Over the next few weeks, as companies tally their financials for the quarter that ends on Thursday, many people are likely to stumble upon an unpleasant insight: The economy is in worse shape than they had thought.

Why the gloominess? It’s all about earnings.

Merrill Lynch strategist Richard Bernstein, for instance, fired off a research note on Monday warning clients to brace for a “tsunami” of profit warnings from cyclical companies, according to Reuters.

“Consumer staples’ negative earnings revisions may be the ripple preceding a tsunami of downward revisions among more cyclical stocks,” he reportedly wrote.

Tellingly, Bernstein is not one to make headline grabbing, hyperbolic statements. In fact, he’s credited with not signing on to the general euphoria during the 1990s bubble.

Buttressing the bearishness is the fact that a number of global consumer giants, including Colgate-Palmolive Co., Coca-Cola Co., General Mills Inc., Cadbury Schweppes Plc, and Unilever Group, have issued disappointing earnings news.

Further, in an interview with the Financial Times this week, Neville Isdell, Coke’s new chairman and chief executive, said his company’s turnaround could take as much as two years.

In another sign that things might not be as good as they’ve seemed, the Conference Board reported that U.S. consumer confidence unexpectedly fell in September for the second straight month. The drop is thanks to the weak jobs market and surging oil prices.

That means consumers are likely to spend less and, in turn, companies will earn less.

Meanwhile, both cyclical companies and consumer-oriented corporations are being hurt by the surging prices of raw materials, including oil (which is breaking $50 a barrel), gold, and copper.

Since most companies haven’t been able to pass on those added costs, they’re absorbing them. The result has been depleted margins and lower-than-expected earnings.

Indeed, downward earnings-forecast changes among the Standard & Poor’s 500 have outnumbered upward changes for five straight weeks, according to Reuters. What’s more, the ratio of upward revisions to downward revisions for September will likely wind up being the lowest since March 2003, according to the wire service.

Last week alone, there were just 26 positive forecasts compared with 46 negative outlooks, which works out to a ratio of 0.57. For all of September, the ratio is closer to 0.55.

Even the gainers can be a source of pessimism. The two groups expected to report the strongest earnings growth in the September quarter are basic materials, which are expected to report 62 percent earnings growth, and energy-related companies, which are expected to take in 37 percent more in profit, according to Reuters.

The projected boom among those big cost-producers, ironically, adds to the impression that the current economic picture isn’t a pretty one.