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B. Nelson: It’s good to be here.
Interviewer: So with third-quarter earnings season just about wrapped up, how have the reports been overall?
B. Nelson: I think the reports have actually been very good. On a trailing four-quarter basis, with the companies that have reported on the S&P so far and estimating those that haven’t, we’re looking at all-time highs again on a trailing four-quarter basis. We have now surpassed the levels seen prior to the Great Recession. I think corporations are now seeing very strong earnings growth. In fact, roughly 75% of the companies that have reported earnings thus far, of the S&P 500 that have reported, have actually beat expectations, and we’re seeing bottom line expansion of about 15%, so these are very strong results.
Interviewer: Very interesting. Where did these better than expected results come from?
B. Nelson: I think most of the earnings expansion has come from cost-cutting measures as well as efficiency initiatives, but a lot of the companies have also posted very strong top-line expansion. In fact, over 60% of the companies that have reported so far in the third quarter have beaten consensus sales forecast expectations, and even companies that missed on the bottom line had fantastic results, two examples being Apple (AAPL) as well as Amazon (AMZN). And the top line growth isn’t shabby. In fact, we’re seeing a double digit top-line expansion in the third quarter.
Interviewer: What were some of the strongest reports, in your opinion?
B. Nelson: I think one of the stronger consumer reports that we’ve seen, which was actually more recently, is Walt Disney (DIS), which reported a very strong quarter with media networks revenue up 9% and revenue from its resorts and parks up 11%. This is on higher ticket prices as well as increased attendance. And, in fact, Walt Disney for the first time in a while saw earnings expansion, income expansion, from all five of its business segments. So people are going on vacation, they are spending money, and they’re also buying premium coffee. Starbucks (SBUX) had a very strong quarter. In fact, US comps were up 10%, global comps were up 9%, partially due to strong loyalty programs as well as some unique fall offerings, but nonetheless people have continued to buy Starbucks coffee.
Within the airline space, Priceline.com (PCLN) for example saw its highest quarterly airline ticketing revenue in the last seven quarters. That’s also been very strong. Then of course what you may already know with smart phone adoption, Qualcomm (QCOM) had a very strong quarter, and so did Apple. Though it did miss on the bottom line, the growth was very strong, and we think the 4S adoption will continue to be a key driver for Apple later this year. I think also when you look at the online consumer, Amazon posted very solid top line expansion, and eBay (EBAY) for example had its highest quarterly revenue growth in the last six years, and we hold that one in our Best Ideas portfolio. We think that name is a bargain at these levels and we think, to a large extent, you are getting PayPal for free. So, despite all the worries you may see in the media with respect to Europe and also concerns with the domestic economy, the third-quarter reports were actually very strong, and this may come as a surprise to many.
Interviewer: What about industrials?
B. Nelson: I think you’re right. The industrials are a key driver to assessing the global macroeconomic environment, but we’ve seen some strength out of the industrials sector as well, and one thing we continue to look at Valuentum are the order books at Boeing (BA) and Airbus (OTCPK:EADSY). Boeing and Airbus have roughly 7 years of backlog waiting to be delivered. These are unfulfilled deliveries of commercial aircraft, and we think this is very positive for the commercial supply chain and should mitigate any cyclicality over the next several years if we enter into a weak period in Europe or a slowdown domestically.
But while we’ve been positive on aerospace for a while, we also saw a very strong report out of Caterpillar (CAT). In fact, Caterpillar had a record backlog, again, unfulfilled orders. In its third quarter it also had the highest sales, highest operating margins, as well as the best operating cash flow in its history. So these are bellwether industrials that are putting up strong numbers. Honeywell (HON) and General Electric (GE) had very similar stories with very solid organic sales expansion of 8% in their respective quarters. In fact, GE’s industrial backlog increased sequentially to $191 billion. So you have these bellwethers suggesting that we aren’t entering into a global recession.
In fact economic growth is still very resilient. I think probably the most telling assessment within the domestic economy for the third quarter has been rail volumes, actually assessing what is moving about within the US on rail gives a good idea of how the economy is tracking. Union Pacific (UNP) had very strong freight revenues for the quarter. In fact all six of its end markets expanded, with industrial products up 24% in Union Pacific’s quarter. So, goods are moving around the country, industrial names continue to see order growth and backlog expansion, and we firmly believe that economic activity is not contracting. And as we outlined in our Best Ideas newsletter (October edition), we think a recession in the US is nowhere in sight.
Interviewer: What about some of the weak reports?
B. Nelson: Obviously there are going to be some winners and some losers in any earnings season. Outside of some of the high beta names like Green Mountain Coffee Roasters (GMCR) or Netflix (NFLX), looking at some of the bigger names like Kellogg (K)--we think the firm had a very poor quarter, because it cut very deep within its supply chain during the Great Recession to boost margins. This is coming back to haunt them as they have to reinvest in their supply chain to shore it up to get things going again. Commodity prices were also the headwind for some companies, such as Clorox (CLX), which is a name that continues to face higher commodity prices and can’t push prices to offset that. This is in stark contrast to a solid name like Kraft (KFT) that’s able to raise prices. In fact in the third quarter it had seven percentage points of pricing expansion to offset these commodity costs.
This was a very controversial quarter in terms of the assessment for 3M (MMM). It indicated that it was seeing weakness in terms of orders from its customers. We think this is relatively isolated to one specific segment, the LCD film segment, which we thought heading into the quarter was going to be weak. And when we look at 3M’s performance, five of the six segments did perform very well, with the LCD film segment being the sole weakness. Finally, Alcoa (AA), which kicked off earnings season, had poor results due to lower metal prices, but when you look at the end market expansion of Alcoa in its third quarter, it is absolutely phenomenal. Commercial transportation, automotive, and aerospace end markets were up huge for Alcoa.
Interviewer: So kind of a mixed bag to some extent?
B. Nelson: Yeah. I think it’s fair to say we had some winners and we had some losers in the third quarter. But I’d say the reports were much more positive than they were negative. But the markets are always forward-looking. The third quarter is now behind us, so we’re looking ahead to the fourth quarter and 2012. Companies that did come out with guidance, a good majority of them lowered their guidance relative to those that raised it. So we’re still very cautious, we’re still evaluating the global macro environment. We’re not taking the Eurozone problems lightly. We continue to analyze the debt situations of Italy, Spain, of regions that are facing very serious debt situations (Greece), but for the most part we think the US global economy is on track. Corporate America is reporting strong results, and we’re seeing that not only out of the bellwethers that we’re talking about today, but also out of names in our Best Ideas portfolio, and we think our Best Ideas portfolio is very well positioned to capitalize on the strength that we’re seeing.
Interviewer: Thanks Brian.
B. Nelson: Thank you.