By Brian Sozzi
Mr. Market has a tough gig of trying to predict the future while at the same time paying close attention to the clues of the present. Actually, come to think about it, Mr. Market has a dual mandate much like the Federal Reserve. Mr. Market has added new job responsibilities in 2011, juggling the clear positives underlying the two-year bull run (strong corporate earnings, accommodative Fed policy and improved economic data trend) against the backdrop of black swan events (Libya and Egypt uprisings, Japan disaster, S&P smackdown on our credit outlook, and the potential for increased terrorism in the wake of OBL death) and known growth deterrents (inflation creeping into the consumer balance sheet, EU debt drama, and deficit reduction plans by the government).
Interestingly, the market is placing on the backburner the downside risks to earnings from those whose fortunes correlate to the fortunes of the U.S. consumer. Note that from April 1 up until the first 1Q11 earnings report from a retailer, Wolverine Worldwide (WWW) on April 19, the S&P Retail Index only tacked on six points. As the bulk of 1Q11 reports arrived from April 19 to April 29, the S& P Retail Index added 15 points. Total gain for the month of April: 4.04%.
So amidst the litany of doom and gloom commentary on the health of the U.S. consumer, how did a rally in discretionary names ensue in the second half of April? What is surfacing in these reports that are sparking confidence on the part of investors to allocate fresh money? Some explanations ...
1. It all begins with sales: To get the lowdown, I compiled data on 11 of the most visible consumer focused companies to have announced 1Q11 results thus far. Absent from my list are Starbucks (SBUX), Liz Claiborne (LIZ) and RadioShack (RSH) as I view them as outliers to the broader sector's performance and not donning canary in the coalmine status. I found that the average sales beat relative to consensus was $28.0 million, not too shabby as commentary on 4Q10 earnings calls and February/March analyst events was downbeat. The trophy for surprise revenue performer goes to Whirlpool (WHR), which beat consensus by an eye-opening $140.0 million, despite a softening in the fundamentals of the housing market (the case here was one of a reset to consensus expectations coming into the year). The major buckets containing the explanations for the upside are pricing power (modest price increases on like items year over year and the introduction of new, innovative product lines), international, and the good ole U.S. Speaking of pricing ...
2. it often leads to happy tiding on the earnings line: Strength in sales owing to the reasons I outlined above fed right into gross profit margins. Companies I analyzed expanded gross profit margins year over year, no small achievement given inflation creep and deflation comparisons to 1Q10. On average, gross margin for my sample set rose 96 bps year over year in the quarter. Big winners included Dinequity (DIN) (476 bps), Columbia Sportswear (COLM) (250 bps), and Avon Products (AVP) (210 bps). Marry the success on gross margin to the continued expense mindfulness by management, and I was not taken aback by the average EPS beat for the group amounting to $0.13. In a few instances, may I add, that a lower tax rate (greater portion of sales being done internationally), lower share counts, and relief on interest expenses through debt reduction bolstered the performance on the upper income statement line items. All in all, quality EPS beats for 1Q11 from my sample group.
Vendors to retailers have been the success stories to date: Generally, these companies are able to pass along price increases to customers and retailers during bouts of inflation. Retailers report 1Q11 numbers starting next week, and we may have a different case than the first wave of earnings releases as price increases can only be passed along in certain circumstances.
Inventory building: Vendors have bought a significant amount of raw materials in advance of demand in order to mitigate cost pressures. We may be set up for knocks to ROA and ROE measures in 2H11 if the consumer retrenches, hence leaving vendors with unproductive inventory.
Innovative product award: Columbia Sportswear.