Themes from Q2 2021 earnings season

by Badgley Phelps | Sep 28, 2021

As summer comes to an end and the second quarter earnings season sunsets, we have observed several themes from management commentary. Most businesses have moved beyond the abnormal comparisons from the COVID-19 disruptions one year ago and aggregate S&P 500 earnings estimates have surpassed pre-pandemic levels to a new record high. In the second quarter, 87 percent of companies reported earnings that beat expectations, and in aggregate, corporate earnings were approximately 17 percent higher than initial estimates.

A cautious approach to guidance

Despite the overwhelmingly strong earnings reports in the second quarter, some management teams who have provided forward guidance have taken a cautious approach given continuing uncertainty around the spread of COVID-19. Other management teams stopped providing annual guidance in 2020 when COVID emerged and have not reinstated formal forecasts since that time.

Strong demand; struggling supply chain

Another factor leading to management reticence to provide a detailed annual earnings projection is the uncertainty related to both demand and supply. Demand remains strong from consumer and corporate clients. Both consumer net worth—at an estimated $144 trillion—and corporate profits, which increased by $235 billion in the second quarter, are at all-time high levels. Consumers have benefited from the increase in home prices and in their investment accounts. Some people are also benefiting from higher wages. Home prices through the end of June (the most recent published data) rose 19.1 percent compared to last year, as the inventory of homes for sale remains low and demand has stayed high. In the August Employment report from the Bureau of Labor Statistics, wages—as measured by the average hourly earnings of all employees—rose 4.3 percent year-over-year.

On the corporate demand front, businesses are healthy and willing to spend. Corporations have reported record levels of revenues, with aggregate S&P 500 revenues increasing 18.5 percent over last year in the most recent quarter. Given the strength in revenues, management teams are increasing capital expenditure outlays. In the second quarter, private nonresidential fixed investment, a measure of capex, rose to a record $3 trillion according to the Bureau of Economic Analysis. Notably, corporate share buyback announcements have also surged and are near record levels.

On the supply side, management teams have reported that they are struggling with a myriad of supply chain constraints including transportation and logistics challenges, higher input costs, lack of available components, and labor availability. Supply chain constraints have been reported by 98 percent of companies, according to a survey by Evercore ISI. These challenges range from ground transportation issues to port congestion to component availability, specifically semiconductors. As a result of supply chain challenges, 70 percent of companies report that inventory levels are below desired levels.

Logistics challenges resulting in ground transportation delays have stemmed from a shortage of truck drivers and warehouse workers as well as port congestion. Shipping ports including the important Los Angeles/Long Beach terminal, which receives shipments from China, have reported record backlogs with 47 ships waiting to be unloaded in nearby waters at the end of August.

Rising input costs and lack of components

Higher input costs and lack of available components are another issue facing management teams. Higher input costs have resulted from factors including the rising price of oil, a key input of many raw materials, as well as natural disasters impacting factory capacity to produce key raw materials. A barrel of Brent Crude oil was about $51 at the end of 2020, and in mid-September the price has risen to nearly $74, an increase of 45 percent. The widely documented shortage of semiconductors has impacted many industries and is expected to persist through the end of the year.

Labor shortages

Finally, businesses also report that they are having a difficult time finding qualified labor. As of the most recent reporting period at the end of July, the Bureau of Labor Statistics reported a record high 10.9 million job openings. Further evidence of labor scarcity can be seen from a recent Evercore ISI survey, where 27 percent of companies specifically reported this as an issue—the most frequent challenge cited. Until businesses can hire more workers, they may rely more heavily on technology to boost productivity; this trend has been firmly in place since the start of the pandemic when workers were required to stay home.

Summary

In aggregate, the second quarter marked a record for the level of aggregate earnings and revenues, though many market participants believe the rate of growth may have peaked. Going forward, growth is expected to remain positive, but at a lower clip than in the prior quarter given post-COVID normalization as well as some of the supply challenges referenced above. Given these pressures, we remain vigilant about identifying companies which are able to pass through higher input costs by raising prices, as well as those firms able to keep their cost structure contained to protect margins and profitability. We believe the companies that are able to navigate the current challenges successfully will take market share and prove to be compelling investments.

 

Originally published on September 22, 2021

 

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