Q2 Earnings: US Small Caps are surprisingly good

With week 4 and 5 of US earnings now complete US earnings season for Q2 is nominally complete with 93% of companies having reported.

• As of Friday, 459 companies have reported. S&P 500 bottom-up EPS climbed to $29.32 from $29.28 the prior week. Consensus earnings growth is -3% YoY (+1% ex energy).
• The last 2 weeks have been relatively light in the US, skewed towards Discretionary results.

THE KEY TAKEOUTS:

Earnings came in better than expected…

But the beat was largely at the earnings level, with some top-line beat.

• Sales came in only 0.5% higher than expected. Sales revisions remain weak and constant currency revisions are at a 3 year low.
• The breadth is also worse: just 37% beat on sales versus a historical average of 53%

Smalls beat bigs

• One of the largest surprises was that small cap earnings came in 9% better than expectations. It had been thought small caps would struggle as their index had been underperforming large caps.
• The beat though is narrowly led and with not much on sales, suggesting that it’s margin expansion.

People start talking the election:

• First comments on thoughts about the election and potential effects emerged in this quarter. Expect to hear a lot more next quarter.

This was probably the trough for earnings being negative YoY in the USA

• Based on the run rate in EPS in Q2 and where we know the USD is now versus last year, and where oil prices are, it would appear that earnings in Q3 will now be flat YoY and turning to positive YoY in Q4
• But with the market making new highs, it would seem this is being baked in anyway.

Stocks in our Portfolio:

Two stocks of note reported in the last period:

GCP Applied Technologies (GCP US)

• The key point of GCP results is that they reconfirm prior guidance for the full year. Actual results appear 1% light of consensus at the revenue level but 5% better at that EBIT and EBITDA level reflecting good margin progression in Construction Chemicals and Building Materials only partially offset by some margin compression in the smaller Darex segment.
• That EPS was 10% light of consensus will no doubt be explained by implied one-offs or spin/restructuring related charges which will become apparent from the 10Q when this is subsequently published.
• How the market will vote will become apparent in the coming hours which will highlight how optimistic investor expectations were in advance of this only second set of results post the spin out. (NB – the market reached the view that the one-offs couldn’t be fully ignored.

This was a disappointment as one would have liked less in the way of one-offs and better guidance.

Tesla (TLSA US) – we were short, not long:

• The Good – the results missed expectations and the company continues to be loss making (on a GAAP) basis with a little worsening of the gross margin and continuing significant net losses and cash outflow (before deposits for new orders), and capital expenditure is running well behind the guided timeframe which is odd given the very demanding launch schedule for the model 3 (for which reservations are clearly being cancelled).
• The Bad – guidance for 50,000 deliveries during the second half of the year was maintained having implicitly reduced full year guidance the previous quarter, with production volumes apparently on track per early commentary.
• The Ugly – with full accounts due to be published in the following days, not much new news was actually released in today’s announcement, however, on the conference call Musk was able to demonstrate a lack of understanding of accounting by stating several times that Q3 and Q4 would be non-GAAP profitable if it were not for model capital expenditure.