Earnings recession over: CIBC World Markets Inc.
Insurance and mining sectors to lead earnings turnaround
TORONTO, Jan. 25 /CNW/ - When the final earnings reports are in for the last quarter of 2009, TSX operating profits should be up 43 per cent, the first increase since the third quarter of 2008, finds a new report from CIBC World Markets Inc.
"As in the U.S., the forthcoming (TSX earnings) reports will mark the end of the earnings recession, after four down quarters," says Peter Buchanan, senior economist in CIBC's latest TSX Earnings Watch. "The gain for the TSX looks like a tough wall to climb, but will in fact benefit hugely from an easy comparison with a year earlier, when both the Canadian and global economies sank into recession, dragging commodity prices and profits down. In sequential terms, TSX earnings will have to rise by only five to six per cent from the previous quarter to meet expectations."
Mr. Buchanan expects the bulk of the increase will be driven by two sectors - insurance and mining. "Performance (in both sectors) is expected to show striking year-to-year improvement. Insurers lost over $1 billion in the year-earlier quarter as a result of adjustments on segregated funds and some of their other assets and liabilities. That sector is expected to see a well-over $3 billion positive swing in profitability. The diversified mining group, meanwhile, is expected to see a $1.5 billion improvement on a year earlier, aided by the strong metals-led rally in commodity prices. Based on the street's latest estimates, gains in those two segments will account for about three quarters of the total year-on-year rise in earnings."
The report finds that earnings in seven of ten major TSX market sectors are expected to show improvement on the year. Mr. Buchanan observes that after insurance and base metals, health care, info tech and utilities stocks are expected to show the largest increases. He notes that gains by gold and base metals producers should help to lift earnings in the materials sector despite the drag on the chemicals industry from softer fertilizer prices.
"Overall, TSX earnings are expected to show greater momentum than the S&P 500 in six major sectors, including energy, trailing in four others," adds Mr. Buchanan. "A 43 per cent rise in fourth quarter earnings would nevertheless translate into a 26 per cent drop for the year as a whole. That's a sizeable setback, although still better than the 80 per cent decline in earnings in the early 1990s recession, when commodity prices plumbed even greater depths."
He notes that revenue growth has and continues to be a prime concern on both sides of the border. With Canada's inflation rate at just 1.3 per cent in the 12-months through December, many firms are suffering from a lack of pricing power, putting pressure on revenue performance. "Steep job cuts, especially in the U.S., have led to fears that recent profit growth is being fueled excessively by cost cutting rather than "organic" revenue growth, and that companies are effectively improving today's performance at the expense of tomorrow's," says Mr. Buchanan.
"While such concerns remain, some sectors should show fairly good top-line momentum (for Q4 2009). Rising emerging market demand is expected to lift revenues in resource segments like mining. Also likely to see gains are high tech firms and others selling differentiated products, or facing favourable demographics like health equipment and services. Improved market conditions, meanwhile, are a plus for financial sector revenues."
Mr. Buchanan notes that the greater challenge may not be this quarter but rather the targets for the coming year. "While a seemingly high 43 per cent rise in earnings this quarter should be attainable, (TSX) Composite members could face greater pressure validating expectations for a 26 per cent rise in 2010. Although such increases have occurred after past recessions, that has generally been in the context of stronger economic recoveries than we expect this time, given the drag from a scaling back of fiscal stimulus programs in both Canada and the U.S.
"The currency, moreover, has seldom been as large a drag as it is at present. While the loonie's well over 20 per cent appreciation from the spring's lows may help a few sectors, like retailers selling a largely imported product mix, it will restrain earnings to a varying degree across a range of other sectors. Commodity prices, another recent profit driver, are unlikely to advance quite as much this year as they did in 2009, when prices rose by the most in three decades."
He also notes that the recent positive earnings revisions by analysts on both sides of the border (53 per cent of revisions in Canada have been positive as have 73 per cent in the U.S.) means much of the recent improvement in the economy and commodity prices may already be priced into stock valuations. That could limit the potential for a further strong stock rally on the upcoming reports.
The complete CIBC World Markets report is available at:
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