Target is unlikely to be the only company to hit the mark in the upcoming earnings season. The retailer on Tuesday warned for the second time in less than a month that its profits would be hit by an inventory glut. The new guidance comes just days after Microsoft said in another high-profile warning that its earnings would be lower than expected due to unfavorable exchange rates. Strategists expect more companies to issue profit warnings. There will also likely be more companies underperforming estimates once earnings reports come out in July. “Companies need to start steering lower and more conservatively. The input costs and other issues they have are not resolved yet,” said Brian Rauscher, head of global portfolio strategy at Fundstrat. “They are under interest rate pressure. You will have the dollar. If you’re not very clear on your end demand, it’s a very uncertain time.” In its Tuesday update, Target said profits would be squeezed by efforts to aggressively clear shelves of unwanted products. Less than a month ago, Target surprised investors with an earnings shortfall and lowered its earnings guidance. Stock levels at some retailers have been building as consumer demand shifted to other categories as Covid cases fell and consumers returned to social events and other activities. Higher costs are also playing a role, especially as consumers are squeezed by record-high gas prices and soaring food prices. “I think we’re seeing inflation starting to impact certain parts of the market in terms of their margins,” said Patrick Palfrey, senior equity strategist at Credit Suisse. “We’re seeing revenue revisions moving up. Up until the past few weeks, earnings revisions have also been higher, but at a slower pace. And now we’re seeing margins starting to narrow.” Closely watched by investors, margins are simply the difference between the money a company brings in and what it spends. Palfrey said he expects a bigger fork around the margins. “I would imagine that companies with greater margin momentum would have greater operational leverage and benefit from underlying trends,” he said. “I think companies with less margin momentum are vulnerable to negative margins and vulnerable to a slowdown in their business.” Palfrey said earnings revisions for the second quarter were most negative for consumer discretionary and communications services companies. Since the beginning of the year, about 35% of S&P 500 companies have provided positive second-quarter earnings revisions. Earnings forecasts for companies in the index have risen an average of 0.3% year-to-date for the second quarter. In contrast, only 9% of communications services companies see an improved outlook for the second quarter. In the energy sector, around 86% of companies saw second-quarter earnings estimates rise an average of 88.3% this year, according to Credit Suisse. About 50% of materials companies saw estimates for the quarter were up an average of 15%. Palfrey said he expects earnings to grow just 5.2% in the second quarter, less than half the 11.7% growth in the first quarter. But he sees a recovery to a 10.6% gain in the third quarter. However, strategists warn that analysts haven’t revised the numbers down that much and the stock market will react negatively to a spate of warnings and misses. “I think companies will see continued pressure on margins. Companies that are going to see margin pressures will be penalized for it,” Palfrey said. “It comes down to management’s ability to navigate the current environment.” Credit Suisse ranked companies in the S&P 500 based on their margin momentum. Companies with positive momentum included companies such as Chevron, Deere, Honeywell, JB Hunt and 3M. Stocks with low margin momentum relative to the S&P 500 include Walmart, Amazon, Ford, Colgate-Palmolive, and Starbucks. Strategists say there are many wild cards in the economy that will impact earnings prospects, including rising oil and energy prices. “The dollar represents an increasing headwind for business, not a big one, but still something that businesses will focus on, especially for businesses that don’t have pricing power and can’t efficiently or effectively pass on the higher input costs,” Zelter said. “Energy companies and materials companies are better able to pull through this, but tech companies don’t have the same ability to pull through.” Rauscher said he expects an increase in advance notices next week and into July. He said he expects a large percentage of companies to continue to beat expectations in the second quarter, but like the trend that started in the first quarter, will also share a more negative outlook. He expects earnings to deteriorate as companies respond to economic headwinds, but how deep and fast isn’t clear. He said the dollar’s 15% rise is yet to be reflected in profits for many companies with overseas sales. “What is corporate America doing and what are the analysts doing?” said Rauscher. “Is it a slow bleed or will it happen in the summer months when everyone is waking up and starting to drop their numbers? I’m not sure about that.” He notes that the data on the consumer was mixed. “The Fed is tightening. That won’t improve consumer spending. … Crude oil is up. It’s affecting a variety of other things, from gas prices to utility bills to heating,” Rauscher said. “Unless crude oil is down $30 and we can change that dynamic, the consumer is only going one way — flat all the way down in my opinion.” He said not all retailers are facing the problems Target is experiencing but he noted that Walmart has previously spoken out about similar issues.
https://www.cnbc.com/2022/06/07/target-and-microsoft-may-be-just-the-beginning-of-a-worrisome-earnings-trend.html Target and Microsoft could be just the beginning of a worrying earnings trend