"You Only Get To Miss Sales Expectations So Many Times"
With the Q4 earnings season beginning, ConvergEx's Nick Colas reminds that the top of the income statement matters more than the bottom line if we expect further upside to domestic equities in 2014. Revenue growth has been in short supply over the last four quarters, with the companies of the Dow only able to average a 0.6% top line growth rate over the last year. If 2013 was all about multiple expansion in equity markets, then, Colas warns this will be the year when revenue growth must fulfill the promise of a U.S. stock market so near all-time highs. Analysts have been perennial over-optimists on revenues every month since early 2012. Maybe they finally have it right, but that is purely a matter of faith at this point; their track record on this count is not good.
Via ConvergEx's Nick Colas,
The Ford Mustang turns 50 in just a few months, but this storied Baby Boomer icon of a car almost never made it into production. In the early 1960s Henry Ford II, grandson of the Ford Motor Company founder, had just watched the Edsel become the most celebrated flop in automotive history. It was overpriced, overhyped, launched with poor quality, and suffered from questionable styling – especially its “Toilet seat” grill. Worse of all, it bore the name of Ford’s own father and “Hank the Deuce” wanted no part of another high profile vehicle launch. The only thing that kept the Mustang program on track at Ford in 1962-1964 was Lee Iacocca’s constant promotion of the car. He convinced Henry Ford II that the car was the right product for younger buyers and would use largely off-the-shelf components to keep costs low.
In a recent – and rare – interview with Jay Leno (quoted in the 1/6/2104 edition of Automotive News), Iacocca talked about this now-fabled American sports car and revealed a provocative nugget of information. Here is what he said, prefaced with a little background:
The basic story is well-known in automotive circles: the original Mustang’s base price was an affordable $2,400 out the door of the dealership and over the first 2.5 years of production Ford sold +1.1 million units.
What Iacocca revealed to Leno about these early cars tells us something new about how profitable they were: customers ordered $1,000 of options, on average.
The contribution profit margin for a passenger car of the day was about 30%, but options typically carried a 60-70% margin. Using Iacocca’s anecdote, that made the average profit per unit about $1,370.
In the 1966 model year, Ford sold 607,000 Mustangs and - using the profit analysis above - made about $830 million pretax. That translated into $5.8 billion in 2013 dollars, using the Bureau of Labor Statistics’ CPI Inflation Calculator.
Analysts estimate that Ford made $10.8 billion in EBITDA in 2013, which means that the Mustang’s inflation-adjusted profits from 1967 are the equivalent of more than 50% of the company’s earnings power today. Not bad for a car that almost got canceled.
That’s the power of marginal revenues, both from new products and higher incremental profit margins, and how they can create explosive earnings growth for the company that is smart/lucky enough to have them. It is also a story which has been in short supply since the initial economic snapback from the Financial Crisis. Every month for the last few years we’ve tracked both analysts’ expectations and actual revenue growth for the 30 companies of the Dow Jones Industrial Average, and here is a summary of our latest findings:
The just-completed year of 2013 may have been an excellent one for equities, but it was the worst year for corporate revenue growth since the Great Recession. Assuming that analysts have dialed-in their expectations correctly for Q4, the average year-on-year sales growth for the Dow companies was a paltry 0.6% last year. Double digit growth did occur – back in 2010 – but that was admittedly against the easy comps of 2009. Since then, even the mega-names of the Dow – generally well run companies – have had real trouble growing their top lines.
Analysts may have set the Q4 2013 low enough so that we might get some upside surprises as earnings season progresses over the next few weeks. Back in March 2013, the Street thought that the Dow companies could grow revenues by 4-5%. As the year progressed a sluggish global economy poured cold water on those hopes. Estimates now run 1.5% for the Dow companies, and 1.6% for the non-financial names in the Average.
According to their currently published revenue estimates, brokerage analysts expect revenue growth to accelerate from here. For Q1 2013, that 1.5% Q4 comp becomes 2.5%. Then, in Q2 2014, that grows to 3.0%. How about Q3? Yep, more growth, to a 4.2% comp to last year.
At the same time, you might look for a salt mine to accompany these estimates, for our tracking of past analyst modeling shows they are prone to excessive optimism. The now-unimpressive Q4 comp to last year of 1.5% began its life a year ago as a 3.4% expectation. It peaked in March as a very brave 4.6% expectation. From there, it slowly crept back into its shell and shrank to its current size. Which is to say very small indeed.
The contours of this year’s quarterly revenue growth expectations are following those of the current quarter. They coming out swinging in the early rounds, only to be pummeled back into their corner by the brutish form of a global economy barely able to get out of its own way. For the first quarter of 2014, analysts were printing a 4.5% expected comp in May 2013. As mentioned, that has shrunk to 2.5% in less than a year. And that 3.0% growth rate in analyst models for Q2? It was a much more impressive +4% comp in October.
Interestingly, the Street has not yet cut its full-year revenue expectations for 2014. These still remain at 3.8%, close to where they started life in late 2012. If you want to know how an analyst can cut their quarterly numbers every month but keep their annual expectations the same, I don’t have an answer for you.
To paraphrase a Ford marketing message (although not directly from the Mustang), revenue growth has to be “Job 1” for stock markets and the companies they track in 2014. Last year’s market, with its above-average gains, didn’t come for free. If investors want to see further advances – or at least the maintenance of current levels – then revenue growth and its attendant improvements in profits must be part of the picture this year. It is easy to pick on analysts for their wayward estimates. Truth be told, it is actually kind of fun. But inside those numbers sit a fidgety truth: you only get to miss sales expectations so many times before investors grow inpatient. Equity investing may be an optimist’s game, but it is not supposed to be a sucker’s bet. This year must deliver on the promise laid out in last year’ stellar investment results, and it must do so both at the bottom AND at the top of the income statement.
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