The second quarter earnings season has been unlike almost any other. We saw a swift shutting down of economies followed by a gradual reopening creating a highly unusual environment for businesses to operate in.
However, we can draw out some important observations: expectations ebbed and flowed through the quarter indicating the unprecedented nature of this crisis; the timing of economic re-openings and the composition of economies largely determined earnings growth of regions; and, the tech sector proved its strength but there was a wide divergence in fortunes across industries and companies.
The second quarter included a period of almost total global lockdown, followed by gradual and variable reopening of economies. While Asia tended to the see the brunt of the Covid-19-related fallout in the first quarter, for developed markets the full force was felt in the second quarter, most likely making it the nadir of this crisis.
With second quarter earnings now largely complete with around 75% of companies in MSCI All-Country World Index having reported, we are able to draw out some important findings:
- Expectations were heavily tempered going into earnings season but rose as it progressed
- Sector compositions and the timing of economic re-openings drove growth rates across the regions
- The tech sector continued to assert its dominance and defensive stocks performed relatively well
- At the industry and individual company level there were mixed fortunes.
Expectations wane and wax
Earnings have been much better than expected; around 70% of companies have beaten both consensus forecasts on earnings and revenues. This is significantly above the historical norm and partly reflects a rebound in activity but, more importantly, the fact that expectations had been heavily tempered. While earnings came in some 20% above expectations, quarter-on-quarter growth was down around 70% in Europe (compared to -40% in Q1), 35% in the US and 21% in emerging markets.
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While expectations were low, they did rise as earnings season progressed. Initially, both companies that beat and those that missed earnings targets outperformed the broader market on results day, with beats rewarded with greater outperformance than historical averages. However, investors’ expectations quickly adjusted - so much so that the overall outperformance of companies exceeding expectations was much lower than historical levels while companies that missed expectations performed a lot worse than they did in the past. It appears that investors rapidly switched from being under- to over-demanding.
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Industrial make-up and economic re-openings drive growth
Sector composition and the timing of re-openings were the main drivers of differences in earnings growth rates between the regions. Many cyclical sectors saw sharp declines in earnings over the quarter while mega cap growth, technology and defensive stocks proved more robust. Much of the regional disparity can be explained by the fact that technology represents 25% of US earnings compared to less than 5% in Europe.
North Asian markets such as mainland China, Taiwan and Korea, which exited from lockdowns far sooner than elsewhere, saw earnings year-on-year growth of -7%, +2% and -19% respectively - a huge improvement on the previous quarter despite being in or near negative territory.
Tech and defensive winners
Continued strength in the technology sector was very apparent. At the end of July Tim Cook, the CEO of Apple, testified alongside other big tech leaders at the US congressional antitrust hearing. He said that the smartphone business is so competitive that it is like a “street fight for market share”. It was hard to see Apple emerge as anything but victorious after it delivered knockout quarterly results just two days after the hearing. While competition in the tech sector is a complicated issue that the industry and politicians will be grappling with for some time, this second quarter earnings season has showed that technology companies are one of the winners from the fallout from Covid-19.
Unsurprisingly, defensive sectors generally performed well. Healthcare delivered positive earnings growth driven by US strength, and utilities and staples remained relatively resilient. Healthcare and utilities showed positive year-on-year earnings trends. Conversely, earnings in energy were decimated by the collapse in oil prices and falling demand. Industrials were also weak but still posted numbers ahead of forecasts.
Mixed fortunes at the industry and company level
There were industries and even individual companies that proved to be a microcosm of the variable impacts of the pandemic.
In healthcare, pharma and biotech earnings were robust but companies exposed to elective surgery saw a collapse in demand as people postponed non-essential operations. In the communications services sector, there was a huge divergence in performance between media companies that are heavily dependent on advertising revenues compared to, for example, internet service providers that have enjoyed the benefits of huge swathes of the global population working from home.
At the company level, divergence can be seen between different divisions and units. For example, Disney’s streaming service Disney+ won 24 million net new subscribers between April and June 2020 or 266,000 per day, while its theme parks essentially shuttered. Uber saw its ride-hailing unit Mobility eclipsed by its food delivery service Uber Eats, which doubled sales so that it is now bigger than the original ride-hailing business from a revenue perspective.
Deep-dive analysis to unravel Covid-19 effects
More than ever, there’s a need to fully understand the underlying operations of a business because the same event can exert very different pressures within an individual company or industry. In this environment, where companies continue to withdraw their guidance, deep dive analysis can unravel what these pressures are.
