Thu, 27 Oct 2011
Quite a lot of companies have been warning for a much lower fourth quarter than we are seeing in the third quarter, says Morningstar head of equity and credit research Heather Brilliant.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
I'm here today with Heather Brilliant. She is head of our global equity and credit research, and we are going to talk a little bit about third-quarter earnings.
Heather, thanks for talking with me today.
Heather Brilliant: Thanks for having me, Jeremy.
Glaser: So ... a lot of the big companies have reported their third-quarter earnings. Let's talk about some big themes that you have seen emerge there. What are some of the things that you are seeing?
Brilliant: Well, we are about halfway through third-quarter earnings season at this point, and based on what we've seen so far, it looks like the third quarter is actually not so bad. I think overall a lot of the companies that have reported so far have been relatively in line with expectations, the market has been taking it relatively in stride, but the problem actually is that quite a lot of companies have been warning for a much lower fourth quarter than we are seeing in the third quarter.
The other problem or issue, I guess, we've seen in the third quarter is that while sales have held up pretty well across the board, it's actually the margin level--in terms of rising costs--that have impacted some of these companies, where things have been a little bit weaker.
Glaser: Has this been pretty even across sectors, or are some areas showing more strength than others?
Brilliant: Well, we have actually seen some relative strength in the consumer staples area. A lot of consumer discretionary firms have not reported yet, they're on an [off-calendar] fiscal year. But we have seen some strength as well in the third quarter even in places like the steel industry, but that is an example, too, where the guidance for the fourth quarter was particularly weak, because not only is it a seasonally weak quarter, typically, but also there are some concerns around just industrial demand, and that's certainly holding back companies like Nucor, for example.
Glaser: So management has been talking about fourth quarter. What are some of the reasons that they're giving for their reduced or weak guidance?
Brilliant: Well, one topic that has come up quite a lot, and I'll use 3M as an example of this, is that that the companies are saying that their customers are starting to reduce inventories in expectation of weaker demand. And so, what they are really saying is that their orders are coming in weaker already. They kind of have some guidance coming from actual indicators in their business.
That's certainly a concern for the fourth quarter. But I think it's fair to say, too, that at this point with everybody almost universally coming in with some kind of hedged guidance for the fourth quarter, that there is not a lot of incentive for companies to go out on a limb and say "We are going to have a great fourth quarter." It's better to kind of throw your hat in with everybody else, and then if you have a great fourth quarter, you will outperform at that point.
Glaser: Now obviously other than earnings going on right now, the eurozone crisis just keeps bubbling up. Do you think that's having an impact on how people are coming up with their guidance, or the way that people are perceiving earnings over the last few weeks?
Brilliant: I think it certainly has injected quite a lot of uncertainty and that always makes people hedge. So, the more concern people have over what's going to happen in Europe, the more they want to hold back on guidance for the fourth quarter.
That being said, now that we have got a little bit more clarity around what's probably going to happen in Europe and how this will play out, I doubt that all of a sudden the rest of the companies that still have yet to report will start having some better fourth-quarter guidance.
But I do think it's fair to say that during this earnings season, the market action has been driven a lot more by what's going on in Europe, and everyone keeping all eyes there, rather than what's been going on the earnings front.
Glaser: Well, Heather, I'm definitely looking forward to seeing what the analysts have to say about the second half of earnings and we'll see in the fourth quarter how that actually plays out.
Brilliant: Yep. And in general, too, I'd add, Jeremy, that we are not really cutting our fair value estimates. So, as we see what's coming out in the third quarter, even though it's not stellar, it's typically been relatively strong, and even with lower fourth-quarter guidance, and in some cases, some concerns about a weaker 2012, we are still keeping our fair value estimates relatively steady.
We have built a lot of this in, as we have talked about in the past, and I think we really believe that when you look at where these businesses are going, a lot of the downside has already been seen. So, even if they stay weak for maybe another quarter or two or three, it's something that is largely built into our expectations anyway.
Glaser: Well, Heather, thanks for your thoughts today.
Brilliant: Thanks, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.