Will Corporate Earnings Stay Strong?

A lot of mixed news crept into the economy during the second quarter of 2010. The underpinnings of the recovery began to look somewhat shaky as new economic data showed a weak employment market, stagnating consumption, and continued problems in the housing market.

But how did this apparent slowdown in growth during the quarter affect earnings? Sharply improved corporate profitability has been one of the bright spots of the recovery. Signs that businesses were able to perform well in the quarter could be a sign that the mixed economic indicators are a red herring and that the economy is still humming along.

It's hard to draw too many conclusions from only one week of results, but overall results showed growth and improving business conditions. However, unlike in previous quarters, results are not uniformly higher than analysts' expectations.

There are three major possibilities for the ending of this trend. The first is that analysts have simply raised their expectations based on the previous quarter's outperformance, making it harder to beat. Secondly, the large and somewhat surprising productivity gains seen at the start of the recovery are much harder to sustain now. Firms are now being forced to invest to get additional growth. Finally, the aforementioned slowing growth meant that management teams were not able to realize the gains they were predicting. The true culprit is likely a combination of these three factors.

Here's a rundown of some of the major earnings releases this week, including Morningstar's comments and a sample from the earnings call transcript. You can see a complete list of stock analyst notes here, and see all of our earnings call transcripts here.

 Alcoa  got things kicked off last Monday by announcing a strong second quarter and raising its outlook for shipments in the remainder of the year.

It wasn't all good news, however, according to Morningstar's Bridget Freas who is "concerned about the downward trend in aluminum prices, which are now 12% lower than at the start of the year." But she expects that improving demand and production curtailments in China stemming from higher energy costs will support a price recovery, boosting Alcoa.

In Alcoa's earnings call, executive vice president and CFO Charles McLane saw "continuing improvement in � key end markets" and emphasized the firm's ability to generate free cash flow.

 Intel (INTC) had another wonderful quarter, its best ever, as its business really fired on all cylinders.

Analyst Andy Ng described the quarter as "spectacular," and he believes that the second half of the year will also look strong as the corporate PC refresh cycle and Asian demand outweighs a slowing Europe.

CEO Paul Otellini highlighted the "broad-based return of the enterprise and small business segments" during the earnings call. These segments had lagging behind, but it now appears that businesses are willing to spend on IT again.

 

 Yum Brands' (YUM) strength in China and emerging markets helped power the firm through earnings, even as growth is hard to come by in North America.

R.J. Hottovy saw that "China continue[d] to be Yum's primary cash-flow engine" in the quarter but that rising food and labor costs could tamp down on profitability in the short to medium term. Overall, he's still bullish on the firm's Chinese prospects.

In the earnings call, Yum CEO David Novak addressed KFC's struggle to gain sales momentum and promised that Yum was "in the midst of a transformation to truly make KFC a more relevant and better-operated brand."

 Google (GOOG) disappointed some investors with its quarterly results, after it announced a big ramp up in capital expenditures as the firm invests heavily in personnel and infrastructure.

Morningstar's Larry Witt thinks the capital-expenditure expansion will "limit future operating margin expansion," but he still sees Google as well positioned as "search advertising continues to take market share from traditional media."

Google CFO Patrick Pichette reiterated the huge opportunities for advertising in the online sector and how Google is ramping up hiring to meet it.

 General Electric (GE) shares fell as its earnings missed expectations because of weakness in the firm's industrial business. However, GE Capital did much better than expected, and the firm announced that the parent company would no longer need to inject the finance unit with additional capital.

Analyst Daniel Holland was not worried about the decline in the industrial business, and he notes that "the firm is on track to hit its cash-flow targets for the year and expects to have more than $25 billion of cash on the parent balance sheet after the NBC Universal deal closes." This cash could very well be returned to shareholders in the form of share repurchases and dividends in the coming quarters.

CEO Jeff Immelt was quite upbeat about the quarter in the earnings call, describing the quarter as "really great" and discussing how the environment continues to improve. He still does have some concerns about the challenges in commercial real estate.

Three big banks,  J.P. Morgan Chase (JPM),  Bank of America (BAC), and  Citigroup (C) reported this week.

J.P. Morgan was the standout, earning $4.8 billion in the quarter. Morningstar analyst Jaime Peters was glad to see "the improvement in early-stage delinquencies that J.P. Morgan has been reporting for the past few quarters" finally roll into actual net charge-offs. She also noted the firm is unlikely to greatly increase its dividend or buyback shares until it has more guidance on long-term capital standards.

J.P. Morgan management emphasized the strong capital position and balance sheet in the earnings call.

Stripping out one-time gains, Bank of America is operating on a close to break-even level on an ongoing basis, according to Peters. She is also worried about the impact of financial reform on the bank, as the consumer protections and other provisions in the new law could have a big impact on B of A.

CEO Brian Moynihan pointed out that the firm's credit quality is improving and that management is focused on moving the core franchise of the business forward.

Peters saw similar themes in Citigroup's earnings. However, she does think that the company's "larger international business mix is likely to separate it from the pack and benefit it going forward."

Vikram Pandit, Citi's CEO, believes that the bank has "the elements for sustained profitability" and that there are number of positive trends in its business.