Going into this trading week, investors awaited the latest update from the monthly Federal Reserve meeting. The decision made at this meeting would telegraph to the market the length that the Fed intended to maintain it's current monetary policy. On Wednesday, the Fed and Chairman Bernanke did not disappoint. Investors received assurance that the monopoly money flowing into the market would not stop for at least two more years. Yesterday also provided a glimpse into how convoluted the stock market has become. Overlooked due to the Fed meeting, three economic bellwether companies turned in lackluster earnings or guidance. Oracle (ORCL), Caterpillar (CAT), and FedEx (FDX) all surprised today with their downbeat assessments. Individually the stocks sold off with FedEx having it's largest one day decline in over a year. More telling is that the broader market shrugged off these warnings. In the past, a warning from any one of these companies was a market moving event. Yesterday, the market simply yawned and shrugged it off, which appears to be indicative of the slowing global economy. The question for an investor now is whether these three companies face isolated headwinds. Conversely, do their results provide a foreshadowing of what other companies will soon tell us, which will confirm the global slowdown?
Why These Companies Matter
It should be relatively clear why FedEx and Caterpillar can serve as a good barometer for gauging the strength of the economy. With FedEx, you have one of the largest overall freight companies and the largest express freight company in the world. A better economy should equal more goods shipped around the world.
Caterpillar is the world's largest manufacturer of construction and mining equipment. A better economy tends to be marked by increases in overall construction activity and development both in developed and emerging markets.
Oracle is not as easy to define as a bellwether company. It is not the worldwide leader in any business segment in which it operates. However, it is one of the top 20 largest technology companies worldwide in terms of revenue with over $37B in 2012. It can be considered a technology company bellwether because of the diversity of the business segments it operates in. These segments include hardware, software, and services. Customers include both government and private corporations. International revenue made up close to 50% of the consolidated company revenue in 2012.
What Each Company Told Us
FedEx reported Q3 EPS of $1.23 which was far below the consensus analyst estimates of $1.39. Earnings were also down 21% from Q3 of last year when the company delivered EPS of $1.55. Additionally the company lowered its previously issued full year guidance to a range $6.00 - $6.20 from $6.20 - $6.60.
Outside of just the numbers FedEx mostly blamed the earnings weakness on the international express segment. The trends they highlighted in that business were specifically a shift in customers choosing less costly methods of shipment than the express offering. On the earnings call the company continued to discuss future earnings growth in light of cost cutting measures it continues to implement.
The takeaway from these results should give one pause for two reasons. FedEx customers could be telegraphing weakness in their own businesses as they are less willing to pay a premium for express shipping. Secondly FedEx is not seeing substantial topline revenue growth and earnings will contract in 2013 from 2012 if it achieves itsr updated guidance. This shows that FedEx has a lack of pricing power in the market which could be demand related. You can only cut so much cost out of your business before you have to see topline growth or margin expansion to drive earnings.
Caterpillar yesterday reported that its global machinery sales fell 13% for the 3 month period ending in February compared to the same period 1 year ago. This report showed a significant acceleration in its level of sales decline as the same report issued at the end of January only showed a drop in sales of 4%. While the headline number is quite negative, the consensus expectation already calls for sales to decrease by 13% in Q1 2013 from Q1 2012 ($13.9B from $16.0B). This estimate would appear to be at risk if the acceleration in the slowdown seen from January to February were to continue.
More concerning with the Caterpillar guidance is where the slowdown is coming. The SEC filing filed today with the updated guidance said:
Asia-Pacific sales decline 26 percent from the same period a year earlier while North American sales were 12 percent lower. The Europe, Africa, and Middle East region slid 9 percent. Latin America was up 3 percent.
The table below shows the 2012 consolidated revenues for Caterpillar along with their geographical breakdown:
You can see from the above chart that North America and the Asia/Pacific region made up the two largest geographical segments in 2012. Those two regions also have seen the biggest sales decline as noted in the company filing. Latin America was the lone bright spot for the company with a small sales increase.
A few items should stand out concerning both the results from Caterpillar and its read through on the global economy. Caterpillar will have to produce a monster second half of 2013 to reach the analyst consensus revenue target of $63.9B. The below table compares 2012 actual revenue by quarter against the 2013 consensus analyst estimates:
The table shows that, in 2013, the company is estimated to deliver only 22% of their total revenues in Q1. This compares to the 24% of revenues delivered in Q1 of 2012. The table also shows that, in 2012, the company grew revenues from Q1 to Q2 by about 8%. Analysts are estimating that, in 2013, this will increase to a 16% growth rate. Lastly you see that overall revenue growth is anticipated to be negative in 2013.
The company specific details on Caterpillar do not lead to much excitement from an investment standpoint. If the global economy is recovering and growing, why is the world's largest equipment manufacturer expected to see revenue decline? Equally concerning is the read through into the U.S. economy which many think is exhibiting continuing signs of strength. If that is truly the case, you would not expect to see North American sales decline by 12% for the 3 months ending February 2013 compared to last year.
Oracle is the least straightforward of the companies mentioned in the article with respect to their disappointing results. Technology companies with diversified product offerings have not shown signs of weakness recently. This probably is why the stock was down over 6% after reporting disappointing earnings. Non GAAP EPS for the companies Q3 came in at .65 compared to expectations of .66. The market shocker, in addition to the guidance, was that revenue for the quarter was only $9B compared to expectations of $9.38B. The revenue miss was a significant 4% below expectations. The company guided on its earnings call for Q4 revenue to be in a range of down 1% to up 4% from the prior year Q4 revenue of $11.5B. This guidance gives a range of $10.9B - $11.4B which compares to analyst estimates of $11.5B for the upcoming quarter.
In their typical fashion, the executives for Oracle were all over the board in explaining their outlook on the business. They first started out by basically blaming their sales team for not closing enough deals in the quarter. On the call, Safra Catz the President and CFO said:
What we really saw is the lack of urgency we sometimes see in the sales force as Q3 deals fall into Q4
She would go on to talk about how many sales agents the company has recently added and how they ran out of time to close deals in Q3. Mark Hurd, also with the title company President, wanted to reinforce the point about all the new sales people when he said:
We've added over 4,000 people to the Oracle sales force in the last 18 months.
It is nice to see the company speak so highly of the sales team that they have assembled. What is peculiar though is that if you review the company 10K filings, you'll find its disclosed employee headcount. In fact, Oracle disclosed that as of May 2011, it had approximately 27,000 employees in Sales in Marketing. In May 2012, it disclosed that its had approximately 30,000 employees in sales in marketing. Let's take the liberty of assuming that the entire growth in headcount was sales related. In that case, 75% of the 4,000 new sales employees would have been employed by the company as of May 2012. This could infer that either the company is misdirecting blame and that sales are just soft. Conversely, it might be doing a lousy job training its sales team.
The company also took the chance to note that the sequester deadline in the United States happened to fall on the last day of the quarter. This could illustrate the company just throwing excuses at the wall and seeing what would stick. More consequentially for the market and the broader economy, the sequester truly could be impacting business spending. In which case, the market is overlooking this impact or just does not care.
Lastly, Oracle repeatedly touted its robust pipeline of future orders. It goes without saying that it cannot be too robust in light of the below consensus revenue guidance. In the context of defending the company strategy and future growth Mark Hurd said:
And that really shows up first in the pipeline performance that we've got. Our pipeline is up significantly.
Again it s just hard to reconcile what the company executives are saying compared to the guidance it is giving. Its cloud revenue was down 1% year over year at $238M for the quarter. This is coming from the same company that on the previous earning call said it was shutting out a key cloud competitor, Workday (WDAY), for new deals in Europe. Hard to make sense of that when Workday grew revenues 75% quarter over quarter compared to the negative growth Oracle saw in the cloud.
Oracle is a strong company that generates significant earnings and cash flow. I think the grasping at straws approach to explaining its results and guidance is indicative of the uncertainty that will soon manifest itself across the broader market.
I do not offer a specific opinion on investing in any of the 3 companies highlighted above. All are financially solid and leaders in their industries. It is the second part of that statement which is concerning. As the industry leaders, or bellwethers, start to report disappointing results, will the market finally heed the flashing warning signs? It is for this reason I continue to urge caution and to analyze what the financial results of leading companies tell you about the economy.