Second-quarter earnings season is heating up in the U.S. and markets on this side of the Atlantic have been sensitive to multinational corporate giants missing the mark or, as has been more often the case this week, exceeding expectations.
With U.S. corporate profits coming in strong in recent quarters, investors are likely focused on whether companies have been able to sustain their growth despite energy and raw materials inflation, macroeconomic recovery losing momentum and risk appetite dampened by the plethora of environmental and geopolitical crises that evolved in the second quarter of 2011.
“Top-line growth has been somewhat tepid throughout this recovery, offset by some really nice margin improvement, stemming from cost-cutting during the Great Recession and companies rationalising three plants into two,” Pat Dorsey, director of research at Sanibel Captiva Trust and Morningstar's former director of equity research, recently commented. “What is going to be interesting,” he explained, is “to what extent that might either moderate or even reverse.” Dorsey pointed to wage inflation--particularly in highly competitive sectors such as high tech, commodity cost inflation and growth slowdown in China as some of the key factors that may have challenged corporate performances in the second quarter.
What follows are excerpts from Morningstar’s research reports on a number of industry bellwethers listed in the U.S. and Europe that reported second-quarter results this week. The full analyst notes as well as Morningstar’s Equity Research Reports, which include independent views on the investment case, valuation, financial health and stewardship of the company, are available to Premium subscribers.
Consumer Goods:
Coca-Cola (KO): Coca-Cola KO narrowly beat our expectations for the second quarter, thanks to another very strong performance in international markets, but the results have no impact on our valuation. However, the slowdown in North America will raise some eyebrows and we think this will prevent Coke from achieving its ambitious pricing targets for the second half of the year. Read the full analyst note.
Johnson & Johnson (JNJ): Johnson & Johnson reported second-quarter results that slightly exceeded our expectations with better-than-expected top-line growth. New drug launches helped drive 7% operational annual growth in the pharmaceutical division and we expect this trend to continue over the next several years. On the consumer front, the closure of the McNeil manufacturing site continues to weigh on sales growth. Read the full analyst note.
Philip Morris International (PM): In a difficult consumer environment, Philip Morris’ performance in the second quarter exceeded our internal expectations and consensus estimates. This remarkable development supports our thesis that the best-in-class tobacco manufacturers' pricing power remains intact in most markets, and that price elasticity of demand for cigarettes is robust around the globe. Read the full analyst note.
Financials:
American Express (AXP): Despite the slow global economy and the debt crisis in Europe, American Express fired on all cylinders in the second quarter. The main driver behind the strong results was growth in customer spending. We like the fact that fee income and not interest income has fuelled revenue growth, but we caution that any change in direction in consumer spending could hit hard the firm's top line. Read the full analyst note.
Bank of America (BAC): As previously announced, mortgage-related problems resulted in $20.7 billion of charges and write-downs this quarter, which led to yet another loss for Bank of America. As the company disclosed much of this information in late June the poor results were already built into our model and we are maintaining our fair value estimate. Read the full analyst note.
BlackRock (BLK): Even with all of the turmoil in the markets, BlackRock BLK closed out the second quarter of 2011 on a fairly strong note. The firm's assets under management (AUM) reached $3.66 trillion at the end of the second quarter, a more than 16% increase year over year and a less than 1% gain over the first quarter of 2011. The company is in a good position to meet our full-year expectations, which call for double-digit top-line growth and operating margins in the 35%-36% range. Read the full analyst note.
Citigroup (C): Citigroup blamed its higher operating costs primarily on adverse foreign exchange effects and reinvestment in profitable business lines. Overall, the company's results were in line with our expectations. However, we are reducing our fair value estimate by $5 as we draw out the time it will take the company to achieve normalised earnings. Read the full analyst note.
Goldman Sachs (GS): Goldman Sachs’ second-quarter revenue was disappointing, down 18% from the previous year and 39% from the previous quarter. The main causes of lower revenue were the company's institutional client services and investing and lending segments. Read the full analyst note.
Pharmaceuticals:
Novartis (NVS): Novartis reported second-quarter results that slightly exceeded our expectations across all of the company's operating segments. However, we don't expect any changes to our fair value estimate based on the minor outperformance. New product launches continue to drive top-line growth and mitigate the patent loss of cardiovascular drug Diovan. Read the full analyst note and watch Morningstar’s 5-minute take on the European pharma sector.
Services Sector:
ManpowerGroup (MAN): While Manpower reported strong growth for the second quarter, there was also some moderation, as the uncertainty that has gripped the global business environment slowed customer demand slightly. We expect this trend to continue into the third quarter until the weight of several economic negatives start to subside. Read the full analyst note.
Technology:
Apple (AAPL): Expectations for Apple's third-quarter results were high, and the company handily crushed them. We are reviewing our fiscal 2011 and 2012 estimates but don't expect a meaningful change in our fair value estimate. Read the full analyst note.
eBay (EBAY): There was ample evidence in the second quarter to support our thesis that eBay is well positioned to be a major e-commerce hub for years to come. We plan to make some adjustments to our near-term assumptions based on eBay's year-to-date results but they will not be material enough to affect our fair value estimate. Read the full analyst note.
IBM (IBM): IBM reported solid second-quarter performance with 5% year-over-year growth in revenue excluding the effects of currency movements. Revenue growth was driven by strong demand in growth markets, which grew 13% at constant currency and accounted for more than 21% of IBM's total revenue. . Read the full analyst note.
Intel Corp (INTC): Intel reported solid second-quarter results, as the firm once again posted record quarterly revenue. The results included the first full quarter of sales from recent acquisitions McAfee and Infineon's wireless chip business, which contributed about $1 billion to the top line. Even when excluding these purchases, the firm had a nice quarter, even though the June quarter is typically seasonally slower. Read the full analyst note.
Microsoft (MSFT): Microsoft's MSFT fourth-quarter performance was consistent with our thesis: Windows revenue declined because of weakness in the PC market while the Microsoft Business Division and the server and tools division delivered solid growth. We are maintaining our fair value estimate. Read the full analyst note.
Telecommunications:
AT&T (T): Our expectation that the loss of iPhone exclusivity will have only a modest impact on AT&T over the near term continues to play out. The firm bounced back from a relatively weak start to the year, adding 331,000 net new postpaid customers during the second quarter, with defections ticking up only slightly. AT&T’s balance sheet should be in good shape if the T-Mobile deal closes as planned next year. Read the full analyst note.
Nokia (NOK1V): It comes as no surprise that Nokia's second-quarter results were something of a train wreck. Handset volumes plunged at both the high end and low end of Nokia's portfolio, and the company posted an operating loss and burned cash. We expected as much, and therefore our fair value estimate remains unchanged. Our thesis remains that while there is a chance that Nokia could fall into a death spiral if its Windows phone efforts fail, we still think that the firm is more likely to survive. Read the full analyst note.
Telenor (TEL): Telenor TEL reported strong second-quarter results, with revenue up 7% year over year. The firm's Asian operations remain the key growth driver, gaining 21% in local currencies on the back of solid subscriber acquisitions in Bangladesh, India, Malaysia, Pakistan and Thailand. Read the full analyst note.
Transport:
United Continental Holdings (UAL): United Continental Holdings reported strong second-quarter results that proved the carrier can achieve profitability despite higher fuel prices and a sluggish economy. However, the earnings were still modestly below our projections and similar to last quarter; we still maintain that airlines are unable to raise ticket prices enough to offset the impact of higher fuel costs, and we suspect this will persist throughout 2011. Read the full analyst note.
