Macro: Sandcastle economics
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Earnings Watch: Margin squeeze, hiring freeze, and crisis mode
Peter Garnry
Chief Investment Strategist
Summary: Yesterday's earnings releases from H&M, Nike, and Micron added more evidence to our hypothesis that the market is underestimating the margin squeeze that is unfolding at rapid speed. The cost-of-living crisis suppressing demand and rising wages impacting input costs are a dangerous cocktail for many companies including Apple that is lowering its production of iPhones to align with the lower demand. Meta also announced a hiring freeze and potential restructurings highlighting the deteriorating environment. The Q3 earnings season will most likely be a nasty surprise for many investors and analysts, and will likely trigger downgrades and lower price targets adding the next negative dynamic to the equity market.
Warnings signs from H&M, Nike, and Micron
If investors were hoping for good earnings news yesterday ahead of the Q3 earnings season that starts in two weeks they were left disappointed, or maybe even terrified. H&M and Nike both delivered operating margins below estimates as input costs are soaring, and H&M is going as far now as introducing charging for online returns suggesting the Swedish fashion retailer is under pressure. Nike delivered a small positive surprise on revenue but missed on gross margin by 1.1%-points filtering all the way through to FY23 Q1 EPS of $0.93 vs $1.16 a year ago. But two things in Nike’s results must have terrified investors. The company’s inventory levels continued to rise sharply suggesting terrible supply chain management and the company said that it would aggressively begin to reduce inventory in the current quarter. The US sports retailer expect gross margin to decline by 3.5-4%-points in their Q2 as a result of reducing inventory at an accelerated pace.
The weak results from H&M and Nike was not a big surprise to us as we have highlighted many times on our Saxo Market Call podcast and in equity notes that the energy shock is causing a cost-of-living crisis that is severely impacting consumption. But the outlook from Micron Technology was the big shocker as the memory chip manufacturer is guidance FY23 Q1 revenue of $4-4.5bn vs est. $6bn and adjusted gross margin in their Q1 of 24-28% vs est. 33.6%. We knew about the impact from the cost-of-living crisis and the signals from memory chip manufacturers have increasingly been bad, but this slowdown is dramatic and pointing towards rapidly deteriorating demand for consumer electronics. That is also why we warned about Apple’s earnings in our equity note yesterday, and that it is likely to impact the entire market sentiment and overall Q3 earnings season.
Finally, Meta announced yesterday that it is implementing a complete hiring freeze and that restructurings are under way. The technology company is under pressure in its advertising business from the data privacy update in iOS and slowing marketing demand as companies are cutting costs. On top of that, Meta is spending $10-12bn annualized on its Metaverse which is likely insanely expensive in the current energy shock with high electricity prices and venturing into a new platform might also not be the first priority of most companies these days.
Analysts are living in an alternative earnings universe
Consensus estimates for Q3 EPS in S&P 500 are still pointing toward q/q growth and as we wrote in yesterday’s note this equates to new record profit margin when we factor in consensus estimates for revenue which is set to decline. To us things are not adding up any longer and we expect revenue to continue increasing or being flat while EPS will take a big hit reducing the net profit margin in the S&P 500 by around 1%-point to 11.7%. Rising input costs now coming from wages which is the biggest operational expense item will drastically reduce margins in the upcoming earnings season and guidance will be uncertainty and weak from many companies. This will likely lead to a lot of downgrades and as we said many times recently trigger the next negative dynamic in the equity market leading to further declines.
Next week’s earnings
The list below highlights the most important earnings releases next week. Our focus will be on earnings from Biogen and Tesco. With the excellent news three days ago from Biogen and its Japanese partner Eisai that it has a treatment that slows Alzheimer’s in a large phase 3 trial, we expect Biogen to more about the potential for this drug if it is approved in the future. The news about this Alzheimer’s treatment is generally a great news for biotechnology investors that have suffered this year, but it also underscores why biotechnology should be part of long-term investors’ portfolios. Tesco is not usually a very interesting company but its FY23 1H result (ending 31 August) good be worth watching as Tesco has a large exposure to the UK consumer and as a grocery retailer can give insights into whether inflationary pressures are beginning to ease or not.
- Tuesday: Biogen
- Wednesday: Keurig Dr Pepper, Aeon, Lamb Weston, Tesco, RPM International
- Thursday: Seven & I, Conagra Brands, Constellation Brands, McCormick & Co
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