Head of Equity Strategy
The Q2 earnings season is almost complete in the US and the numbers are stacking up to be the best seen since the Great Financial Crisis. S&P 500 companies had 9.3% year-on-year growth in revenue and 8.6% y/y growth in EBITDA per share (given the extensive share repurchase programmes the actual EBITDA growth was likely lower).
Next week, 64 companies will report earnings out of the 2,000 companies we track during earnings season. As we communicated in our latest equities webinar, the latest earnings season has been the main driver behind the summer rally in global equities. With the MSCI World index below the highs from January but underlying earnings higher, the valuation picture has improved short-term and the long-term positive picture is intact given leading indicators remain positive.
Next week's main focus will be Chinese bank earnings with China Construction Bank (Tuesday), CITIC (Wednesday) and ICBC (Thursday) reporting Q2 earnings. All three banks are reported to show robust earnings growth but the recent slowdown in China has negatively impacted construction spending and likely increased bad loans. Investors will focus on bad loans and impairment ratios while keeping a sharp eye on the cost/income ratio of Chinese banks as there has been an increasing demand for reigning in costs. CITIC is expected by sell-side analysts to perform the best of three banks despite its bigger exposure to a brokerage business that has likely suffered somewhat from the worsening investors sentiment in China.
The three releases will hopefully give clues to whether they expect to follow the demands of the government to extent credit into the economy to boost activity. As we have been saying on our Morning Calls lately, the Chinese government has communicated that it sees a weakening credit transmission like what Europe has experienced which potentially leads to unconventional measure by the People's Bank of China going forward. But most importantly, strong earnings from Chinese banks are essential fuel for a rebound in the broader Chinese equity market.
Will Salesforce continue to deliver high growth?
Salesforce, one of the earliest movers of cloud-based technology platforms, reports Q2 earnings on Wednesday (after-market) with analysts expecting EPS at $0.47, up 43% y/y, and revenue of $3.23 billion, up 26% y/y. Salesforce has grown revenue by 25% consistently for a decade while slowly expanding its EBITDA margin as the business reaches economies of scale. As with Amazon, investors have always focused on accounting earnings with Salesforce instead of looking at the cash flow generation. Because of the massive upfront spending in growth and subscription model, there is a mismatch between the accounting figures and the cash flow figures. In the past 12-month Salesforce generated $2.5bn in free cash flow and with an enterprise value of $105.8bn this squares to a little less than 2.5% free cash flow yield. We expect growth to continue driven by deeper penetration of the existing client portfolio but also international expansion and potential topped with some add-on acquisitions.
Chinese tech: The growing margin concern?
Chinese ecommerce bellwether Alibaba reported FY'19 Q1 earnings yesterday, which was a highly anticipated release given the series of weak earnings from other Chinese technology companies. The company reported 61% y/y which was a bit higher than estimated, but the weak point was the sharp EBITDA margin contraction with Q1 seeing 9% (on adjusted basis) down from 42% a year ago. The bigger issue for many Chinese technology companies is the pursuit of growth is forcing Tencent, Alibaba, and Baidu to diversify away from their core business into secondary businesses with lower profit margins. The margin pressure will likely be a continuous theme for Chinese technology companies going forward, eating away some of the high top line growth. We are short-term sceptics of the Chinese technology sector but long-term bullish on the sector.