“Uncertainty” will be the buzzword on conference calls during Q1 earnings season, which kicks off this week.
Profit growth will decelerate meaningfully following the post-pandemic surge, and management teams face a daunting communications challenge as investors fret over margin headwinds.
Consensus expects aggregate S&P 500 EPS growth to come in at just 5% for Q1 (figure below). The figure was near 50% a year ago and peaked near 90% in Q2 2021, as results benefited from the pandemic comp.
Earnings growth should reaccelerate into the back half of the year. Or at least that’s the plan. And you know what they say about the best-laid plans — something about how they never go awry.
Although the usual gamesmanship means an across-the-board disappointment is unlikely, it wouldn’t be surprising (at all) to see a bevy of guidedowns considering the macro backdrop. Persistently high inflation is problematic on both ends: Input costs are higher and passing those costs along to consumers jeopardizes demand, especially for discretionary goods and services. At the same time, labor costs are rising at a virtually unprecedented rate.
“Pricing power will become increasingly important in the face of continued inflation and cost pressures,” Goldman’s David Kostin said.
For now, topline growth provides some cushion, but the juxtaposition with margins will stand out. Although revenue growth is seen at 14%, margins will likely contract. If that’s the case, Q1 2022 would be among the only observed instances of net margin contraction and double-digit topline growth in three decades, according to Goldman. The only other two quarters occurred in 2008 and 2011. “Similar to the current macro environment, those periods were marked by relatively high inflation and sharp increases in crude oil prices,” Kostin remarked.
The table on the left (below) gives you a snapshot of the sector breakdown. Energy is the anomaly. EPS growth there is seen at a ridiculous 250% YoY, aided by surging prices and 624bps of margin expansion. Consumer Discretionary, by contrast, could be a train wreck. Profits are seen falling double-digits amid sharp margin contraction tied (one assumes) to higher labor costs and ongoing supply chain disruptions.
The figure on the right (above) is potentially problematic, although the dashed line suggests revisions aren’t actually that disconnected from the macro reality, at least for Q1. “Despite shocks from war, spiking commodity prices and a hawkish Fed pivot, consensus estimates for Q1 have only been trimmed by 0.9% YTD,” Goldman’s Kostin noted.
Plainly, management teams will be compelled to address the conflict in Ukraine and update investors on how resilient (or not) business models are to ongoing geopolitical risk and lingering supply chain disruptions. At this point, it’s probably fair to suggest that irrespective of your views on any “new world order” frameworks, the days of relying entirely on various manifestations of a just-in-time mindset are over.
“Pandemic lockdowns and the Russian invasion of Ukraine have reinforced the need for firms to evaluate their global exposures,” Goldman went on to write, adding that “firms that have recently halted business in Russia will likely need to take impairment charges to account for asset write-downs.”
Shell was in the news last week after announcing a multi-billion dollar impairment tied to its withdrawal from Russia. The New York Times has a handy list of firms which have and haven’t “quit Putin.”
Goldman also addressed the expected reacceleration in profit growth mentioned (and illustrated) above. Suffice to say Kostin is skeptical. “Analysts appear reluctant to adequately trim forecasts despite the high degree of uncertainty surrounding the economic outlook,” he remarked.
