3Q19 Earnings Preview: Margins in Focus, Trick or Treat?

Third quarter earnings kick off this week with expectations of a single-digit decline in S&P 500 margins after slight contractions over the last two quarters. To set the stage for a busy earnings season, we used Amenity’s NLP models and text analytics tools to look closely at how public companies spoke about margins on earnings calls last quarter. We present our analysis of trends in margin commentary below.

Setting the Stage

Historically low unemployment, incremental growth in wages, falling interest rates, and flickering signals of easing trade tensions have kept hope afloat for the health of US consumers that are driving economic growth. However, pitched against that backdrop are growing input costs and ongoing commercial uncertainty stemming from geopolitical rifts that continue to churn.

Analysts expect these uncertainties to extract a pound of flesh at some point. Wage growth may be good for consumers but it can come at the expense of corporate margins. A strong dollar complicates things for the S&P 500, for whom 40% of sales come from abroad. Financials are feeling the squeeze in a lower rate environment that undermines their net interest margins. Energy firms are dealing with low crude prices while technology firms wrestle with trade tension. And despite good household economic health, consumer confidence is on an apprehensive footing going into a busy consumption season.

All this is to say that earnings performance and forward looking guidance for the remainder of FY20 will be heavily scrutinized. Early reporting from financials this week will set the tone for the remainder of this earnings season, and so we think it is wise to start from an informed position on where things stand.

Quantifying the Margin Story

Figure 1 below presents Amenity’s sentiment analysis of margin commentary by S&P 500 companies last quarter. The x-axis corresponds to the net polarity for average companies in each sector. The y-axis corresponds to the number of events detected in the earnings call of average companies in each sector. And the bubble size indicates the relative number of companies engaging in margin commentary.

Figure 1: 3Q19 S&P 500 Margin Commentary by Sector

What we observe is a positive margin story being told by all sectors but Utilities with relatively higher focus paid to margin related commentary by sectors higher on the x-axis (e.g. Industrials, Consumer Discretionary, Information Technology, etc.).

For analysts and investors curious about which S&P 500 companies discuss margin most positively and negatively, Figure 2 below details those S&P 500 companies with the highest counts of positive margin events and negative margin events.

Figure 2: 3Q19 S&P 500 Margin Commentary by Company, Ranked by Polarity & Count

We provide illustrative commentary from the top three calls in the positive and negative rankings below:

Positive Margin Commentary:
  • Cintas - "Well, we had a real nice gross margin quarter with the gross margin being up 110 basis points."
  • Parker-Hannafin - "Even with lower sales, operating margins improved nicely for the fourth quarter to 18.4% on an adjusted basis."
  • AmerisourceBergen - "If we kind of look at the overall business, revenue’s up 5%, gross profit up 5%, operating expenses up 3.7% and op income up 6.8%."
Negative Margin Commentary:
  • BorgWarner - "To be clear, we’re not satisfied with our margin performance in the full year ’19."
  • LKQ - "Again, our expectation would be – it’s going to be tough sledding for the rest of the year."
  • Advance Auto Parts - "…we’re covering these costs with pricing actions, but it makes it more challenging to expand margins in the shorter term."

Reading Ahead to the Next Chapter in the Margin Story

We go a step further to filter for margin commentary extractions that include explicit forecasts, wherein executives discuss future expectations about margin. We present that data at the sector level in Figure 3 below.

Figure 3: 3Q19 S&P 500 Margin Forecast Commentary by Sector

What we observe is a lighter count of margin forecasts events for the average company in the S&P 500 but also a varying concentration in where industries sit relative to one another. Relative to their overall discussion of margins, Communications Services, Consumer Discretionary, and Financials have materially lower net polarity scores with respect to margin forecasts.

Similar to the ranking included earlier, we provide a ranking of S&P 500 companies that discuss margin forecasts most positively and negatively below in Figure 4. These rankings may serve as useful watchlists for analysts and investors curious about the path forward for corporate margins within the S&P 500.

Figure 4: 3Q19 S&P 500 Margin Forecast Commentary by Company, Ranked by Polarity & Count

We provide illustrative commentary from the top three calls in the positive and negative rankings below:

Positive Margin Commentary:
  • Applied Materials - "…as the industry recovers, and we take our company structurally larger, I think you’re going to see the operating margins expand as we grow the company and the investments that we’re making today to drive that future leadership should allow us to outperform as that industry recovers."
  • Teleflex - "…as we move towards the back half of the year, we anticipate further sequential operating margin expansion."
  • Jack Henry - "Margins are going to be very strong in Q1 because we’re going to recognize all of the annual software subscriptions revenue."
Negative Margin Commentary:
  • Intel - "We expect Q4 gross margin to be down 3 to 3.5 points sequentially as we continue to ramp 10-nanometer and will have sold through the previously reserved inventory and will also not see the benefits of the NAND grand."
  • State Street - "…we are cautious enough about the revenue environment that we feel we need to keep doubling down on expenses."
  • Ameriprise - "…what I would just look at is the expenses will be higher for this year, but it’s based on the things I’ve mentioned."

Watch This Space

We’re looking forward to the ramp up in earnings calls and will be in touch with updates and insights as and when they are actionable. In the meantime, please don’t hesitate to reach out with questions.

Interested in running these types of analyses with our platform?

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About Amenity

Amenity Analytics is the industry leader in providing insights from unstructured text by using Natural Language Processing (NLP) assisted by Artificial Intelligence (AI) and Machine Learning (ML). Amenity’s NLP system is a sector-agnostic, language-dependent tool for quantitative text analysis that is deployed across the financial services industry and beyond.

This communication does not represent investment advice. Transcript text provided by S&P Global Market Intelligence.

Copyright ©2019 Amenity Analytics. 

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