To everyone expecting material upside surprise in terms of company earnings, guidance, balance sheet improvement, and/or capital spending, Goldman has one word: don't.
As Goldman's Amanda Sneider says, expect disappointing revenue results and negative EPS guidance. The reason: weaker macro data and dollar strengthening increase the likelihood of sales misses. Goldman also anticipates increased negative earnings guidance as companies quantify the FX headwind. The one positive offset, if not for energy companies, is that the net impact of oil changes on index-level EPS tends to be modest as firms benefit from lower input costs.
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The key concerns according to the squid:
There are only two topics on the minds of investors as we enter the 3Q earnings season: the dollar and oil prices. The EUR/$ weakened 8% during 3Q 2014 following a weaker Euro area outlook and additional easing measures. Brent crude fell 16% during the quarter, with the average price in 3Q 2014 6% below the 2Q 2014 average. Analysts slashed energy EPS estimates, and weaker Euro area growth prompted estimate cuts in other sectors.
In the near term, we expect the stronger dollar will lead to a disappointing quarter for revenues and increased negative earnings guidance. The net impact of lower oil prices on index-level earnings tends to be modest as other sectors benefit from lower input costs even though Energy earnings decline.
Like this preview, we expect managements will address regional growth prospects, FX headwinds, and oil costs in 3Q 2014 earnings conference calls.
We believe domestic-facing stocks will be less likely to miss estimates relative to those with Western Europe revenue exposure. We recommend investors buy a portfolio of the most domestic-facing S&P 500 stocks (Bloomberg ticker: GSTHAINT) versus stocks with the most Western Europe revenue exposure (GSTHWEUR).
In the longer term, US and global growth are more important to our earnings model than currency or oil prices. Economic growth changes associated with moves in the dollar or oil prices will have a greater impact on our EPS estimates than the moves themselves.
The bottom-up consensus estimate for 3Q 2014 is now $29.02, implying 8% growth versus 2013. Ex-Financials and Utilities, sales are expected to grow 5% while trailing-fourquarter margins are expected to expand 6 bp to another new historical high of 9.1%. As the bottom-up consensus full-year 2014 EPS of $117 is slightly higher than our full-year EPS forecast of $116, we expect revisions of -2% to consensus 2H forecasts.
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Why Goldman thinks that Dollar strengthening is prices into earnings but not revenues:
What is the impact of dollar strengthening on 3Q results and EPS in the longer term? This is the most popular question of the season, and it’s no wonder why. The EUR/$ weakened 8% during 3Q 2014 following a weaker Euro area outlook and additional easing measures. Our FX strategists believe the EUR will weaken further relative to the USD to reach parity by year-end 2017 (see FX Views: Revising down our EUR/$ forecast, August 29).
Foreign sales accounted for 33% of aggregate revenue for the S&P 500 in 2013. The median stock reported 29% of sales outside the US. Companies reported that 12% of revenues came from EMEA, with 7% directly attributable to Europe. Approximately 8% of revenues stem from the Asia Pacific region and just 7% of reported revenues were from non-US Americas (Canada and Latin America). The remaining 6% of revenues were foreign but unclassifiable.
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During 3Q 2014, bottom-up consensus EPS estimates for 3Q 2014 fell 3% with estimates falling in every sector but Health Care. Earnings revisions were most negative in the Energy (8%), Consumer Staples (8%) and Consumer Discretionary (7%) sectors.
Revision patterns indicate analysts incorporated dollar strength and a weaker Euro area into their estimates. There is a loose correlation between sectors with higher EMEA sales exposure and the magnitude of earnings revisions.
While analysts reacted to growth and currency changes through earnings estimate revisions, aggregate revenue estimates are unchanged. Materials (-5.9%) and Health Care (+1.6%) saw the largest revisions to 3Q sales estimates.
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Bottom line:
We expect a disappointing quarter for revenues. Weaker macro data and dollar strengthening increase the likelihood of sales misses. We also anticipate increased negative earnings guidance as companies quantify the FX headwind.
And how Goldman wants to trade this:
We believe domestic-facing stocks will be less likely to miss estimates relative to those with Western Europe revenue exposure. We recommend investors buy a portfolio of the most domestic-facing S&P 500 stocks (Bloomberg ticker: GSTHAINT) versus stocks with the most Western Europe revenue exposure (GSTHWEUR).
Translation: do the opposite.
