One week ago, we were surprised to see that none other than data aggregator Factset has joined the "crusade" against fabricated non-GAAP numbers. This is what it said:
For FY 2015, 20 of the 30 companies in the DJIA (or 67%) reported non-GAAP EPS in addition to GAAP EPS for the fiscal year. For 18 of these 20 companies, non-GAAP EPS was higher than GAAP EPS. On average, non-GAAP EPS exceeded GAAP EPS by 30.7% for these 20 companies. For FY 2014, 19 of the 30 companies in the DJIA (or 63%) reported non-GAAP EPS in addition to GAAP EPS for the fiscal year. For 15 these 19 companies, non-GAAP EPS was higher than GAAP EPS. On average, non-GAAP EPS exceeded GAAP EPS by 11.8% for these 19 companies. Thus, there was a wider gap on average between non-GAAP EPS and GAAP EPS in FY 2015 compared to FY 2014 for companies in the DJIA.
Due in part to this wider gap between non-GAAP EPS and GAAP EPS, companies in the DJIA on average reported a much smaller year-over-year decline in year-over-year EPS on a non-GAAP basis than on a GAAP basis for the year. For FY 2015, the 20 companies in the DJIA that reported non-GAAP EPS reported an average year-over-year decline in non-GAAP EPS of -4.8%. These same 20 companies reported an average year-over-year decline in GAAP EPS of -12.3%.
Today, we are just as impressed that in another weekly dose of accurate reporting, Factset takes aim at another just as important aspect of corporate profitability, namely profit margins, which according to its calculations, are set to tumble to just 9.3%, down from 10.0% last quarter, below the 10.2% high reached in Q2 2015, and the lowest since Q2 2012. While much of this is the result of a collapse in energy margins, it appears that this weakness is spilling over and starting to impact many other sectors as well.
Lowest Net Profit Margin (9.3%) Projected for S&P 500 since Q4 2012 (8.9%)
For Q1 2016, the estimated net profit margin for the S&P 500 is 9.3%. If 9.3% is the actual net profit margin for the quarter, it will mark the lowest net profit margin for the S&P 500 for a quarter since Q4 2012 (8.9%). What is driving the weaker projected profit margin for the index relative to recent quarters?
Five of the ten sectors are projected to see lower net profit margins in Q1 2016 relative to the 3-year average for each sector, led by the Energy sector (0.1% vs. 6.5%). The estimated net profit margin of 0.1% for the Energy sector is based on estimated aggregate earnings of $263 million and estimated aggregate revenues of $182 billion for the quarter.
Excluding the Energy sector, the estimated net profit margin for the S&P 500 would be 10.0%. However, this would also mark the lowest net profit margin for the index excluding the Energy sector since Q1 2014 (9.9%). Thus, other sectors are also contributing to the expected lower than average net profit margin for the index for Q1 2016. After the Energy sector, the other four sectors projected to report net profit margins below the 3-year averages for Q1 2016 are the Industrials (7.9% vs. 9.1%), Information Technology (17.2% vs. 18.0%), Consumer Staples (5.6% vs. 6.1%) and Consumer Discretionary (6.5% vs. 6.6%) sectors.
Based on current earnings and revenues estimates, however, the estimated net profit margin for Q1 2016 will reflect a low for the index. Over the next three quarters (Q2 2016 – Q4 2016), the estimated net profit margins for the S&P 500 are 10.1%, 10.5%, and 10.4%. Eight of the ten sectors are projected to see higher average net profit margins over the next three quarters relative to Q1, led by the Energy, Industrials, and Information Technology sectors.
Needless to say, without the bounce in oil, none of this forecast rebound in margins will take place.
But it's not just oil. As Goldman pointed out in a report from earlier this week, one surprising source of margin weakness could be a company that is about as far away from oil as possible: AAPL, where the future of iPhone sales could have a dramatic impact on S&P profit margins. To wit:
We expect that Information Technology margins will fall from 17.9% in 2015 to 17.7% in 2016, as both Apple margins and sector margins outside of Apple decline. Technology margins excluding Apple will continue to decline modestly through 2017 in our view, but a rebound in Apple’s margin will more than offset the decline, pushing overall sector margins up by 6 bp to 17.8% in 2017 (see Exhibit 20).
On its own, Apple (AAPL) has contributed more than 25% of the aggregate S&P 500 margin expansion since 2009 (see Exhibit 21). Roughly half of the Information Technology margin expansion may be attributed to AAPL. Looking forward, Goldman Sachs Hardware analyst, Simona Jankowski, expects that AAPL margins will fall by 40 bp to 22.5% in 2016 before rebounding back to 22.9% in 2017. Without margin expansion leadership from AAPL, Information Technology margins and overall S&P 500 margins will come under pressure. Information Technology sector margins are reduced by 140 bp when AAPL is excluded (16.5% vs. 17.9%).
Appropriately enough, the future of S&P fundamentals is in the hands of oil and iPhones. Note we did not say the price of the S&P - that, as everyone knows by now, is entirely in the hands of central bankers.