Corporate profits at risk as virus spreads
Economy tailed off dramatically in March
Shelter-in-place orders, the shutting down of large parts of the economy and skyrocketing job losses due to coronavirus are bad for America’s economy and for corporate profits.
So be prepared for unsettling news when companies start reporting how much money they made – or lost – in the first three months of 2020. And brace for even worse earnings news when the second quarter ends after June.
While the economy was faring well in January and February, it has downshifted dramatically in March. That’s when the deadly coronavirus spread quickly across the U.S., prompting the federal and state governments to intentionally shutter businesses to slow the spread of COVID-19.
The resulting hit to business activity and jobs has been sizable, despite emergency help provided by the Federal Reserve and a $2 trillion relief bill passed by Congress. Fed chief Jerome Powell says the economy “may well be in recession.” And the hit to Main Street workers has been swift, with a record 3.3 million people filing for unemployment benefits in one week last month.
As expected, companies are making a lot less money due to the unprecedented shutdown of the U.S. and global economy. And analysts haven’t yet lowered their profit projections to fully account for the damage caused by the pandemic. The broad U.S. stock market has already dropped sharply in value as investors have factored in lower future earnings and a coming recession.
It “surely will be a dismal earnings season,” said Peter Essele, head of portfolio management for Commonwealth Financial Network.
Analysts now expect first-quarter profit growth for companies in the Standard & Poor’s 500 stock index to fall 2.9% from the same period a year ago, I/B/E/S earnings data from Refinitiv through March 27 show. On Jan. 1, Wall Street was forecasting profit growth of 6.3%.
The brunt of the profit pain is being felt in the energy industry. Oil-and-gas companies could suffer a profit slide of 32%. The culprit? Less demand for fuel as air and auto travel dries up. Not to mention an oil price war that briefly drove crude prices down 70% to a 52week low of below $20 per barrel.
“Energy was hit with a double black swan,” Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities (USA), said, referring to rare, unexpected events.
Profits of industrial companies, which include names like Boeing and heavy-equipment maker Caterpillar, are seen falling about 23%. Earnings of companies that sell discretionary consumer goods are estimated to fall more than 19%. Companies in the travel and tourism business, such as airlines, cruise lines and hotels, will be especially hard-hit.
On the bright side, the communications services industry is still on track for roughly 11% profit growth. Technology, health care, utilities, real estate and consumer staples are also seen posting positive profit growth.
The big profit drop is likely in the second quarter. It will make the first-quarter numbers “irrelevant” and less important to investors because they reflect business conditions largely before the coronavirus crisis hit, says Bruce Bittles, chief investment strategist at Baird.
“No one has any idea what earnings will be until we get a grasp on the duration of the coronavirus,” Bittles says.
Many Wall Street firms are lowering their full-year profit outlooks. Credit Suisse, for example, sees 2020 S&P 500 profits dipping more than 24%. That’s far worse than the current Wall Street consensus for a decline of 0.5%.
More bad news and more profit estimate cuts will soon be forthcoming from analysts as well as company CEOS. Second-quarter profits for the S&P 500, which were seen growing 7.2% at the start of the year are now seen falling more than 7% versus a year ago, with energy earnings falling more than 77%, Refinitiv data show.
Normally, investors focus on whether companies beat or missed earnings forecasts and why. But this earnings season analysts will be listening for any clues from CEOS related to the health of the company’s balance sheet and whether they have enough cash to keep operations running during what is hoped-to-be a temporary shutdown, says Golub.
“It’s not going to be about beats and misses,” he says. “Do you have enough money in the bank and lines of credit to pay your people, keep stores open, rollover debt – and withstand the shock?”
There’s no question that banks are heading into the COVID-19 crisis in far better shape and with a much bigger capital cushion than in 2008 when they got stuck with tens of thousands of bad mortgages and massive losses.
Still, investors know banks will be pressured by the skyrocketing unemployment rate and the resulting inability of laid-off people to pay their bills.
Investors will want to hear how banks will “reserve for losses” and “how much they will have to set aside,” Golub says.