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Stock Strategist

Third-Quarter Earnings Start with a Bang

Following the second-quarter trend, companies are reporting better than expected results.

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Despite my prediction last week that there was more potential for downside than upside in this quarter's results, earnings season has started with a bang. So far, the better-than-expected results have been driven by two major themes. The first is corporate cost-cutting. As my colleague Bob Johnson has discussed, the flipside of all of the job losses we've been seeing is that corporations have been forced to become more efficient and productive--boosting margins. This is not sustainable--eventually firms will have to rehire to expand--but it is helping results in this quarter.

The second major theme has been the continued reawakening of international markets, notably China. The Chinese desire for raw materials and other goods is helping plump up global demand. With other countries in the region showing stability or even growth, it's possible to see the region as an engine for global growth, as the U.S. and Europe deal with continued economic woes.

Earnings Review
 Yum Brands (YUM) reported results that reflect both of the aforementioned trends. Yum has a lot riding on its expansion in China, and that continued unabated in the quarter. Retail analyst R.J. Hottovy remarked that the firm's "global unit expansion was enough to offset flat same-store sales in the China and international segments and a 6% same-store sales decline in the U.S." Yum managed to improve profitability thanks to declining commodity costs and a reduction in corporate overhead.

 Alcoa (AA) also posted better-than-expected results for the third quarter. Chinese demand was "an important force behind third-quarter price recoveries" according to basic materials analyst Min Ye. China has had six months of high imports, but this is a trend that looks set to reverse itself as the country restarts its smelters. Although this higher supply may have a negative impact on spot prices, the fact that the underlying demand exists is a good sign for the Chinese economy.

Closer to home,  Costco (COST) showed several encouraging signs. Excluding gas sales and foreign currency translations, comparable-store sales rose 1% in the quarter. Costco analyst Hottovy was impressed by improving profitability driven by "higher merchandise margins in the firm's core business, increased private-label penetration, and fewer gasoline sales (which carry a lower margin than other merchandise categories)." He expects that "the firm's exceptional value proposition will continue to resonate with consumers over the coming quarters, leading to improved fundamentals and market share gains. We will wait until the firm's conference call before finalizing any adjustments to our model, but we do not anticipate a significant change to our fair value estimate."

Beverage analyst Phil Gorham believe that  PepsiCo's (PEP) results confirmed his assessment that "the firm is losing ground to rivals in its North American beverage business, but that its snack and international segments continue to perform well." Pepsi's results continue the trend of multinational corporations still feeling weakness at home, but starting to get a lift from foreign operations.

Click here to see all of our earnings notes.

On Tap
Tuesday
 Johnson & Johnson (JNJ) reports before the bell on Tuesday, and we are expecting that demand for new drugs should start to offset patent losses.

 CSX Corp (CSX) also reports, and given that rail demand has not recovered much during the third quarter, we expect earnings to remain suppressed, even with appropriate matching of capacity to demand. Increased train and engine employee staffing during vacation season is likely to increase expenses a bit.

Wednesday
 Abbott Labs (ABT) kicks off Wednesday's results before markets open, and we expect positive details on the recent Solvay deal.  J.P. Morgan (JPM) also reports before the bell.

We'll get a glimpse into the psyche of high-end leisure and business travelers when  Host Hotels (HST) posts results. We're expecting continuing weak demand for luxury travel.

Thursday
Thursday looks set to be one of the busiest during earnings season.

 Citigroup's (C) and  Goldman Sachs' (GS) results will give investors a pulse on the health of the banking industry.

Tech names reporting include  AMD (AMD),  Google (GOOG),  Nokia (NOK), and  IBM (IBM).

We're also expecting results from some consumer discretionary names like  Harley Davidson (HOG) and  Winnebago (WGO). It will be interesting to hear what their takes are on the state of the consumer.

Friday
We close a busy earnings week with two widely held names,  Bank of America (BAC) and  General Electric (GE), reporting. We're expecting that a weak economy and a slow return to spending by companies should pressure GE's earnings in the quarter.

Click here for our complete earnings calendar.

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.