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It has been a noisy start to the year in global equity markets, with the enthusiasm of the first several weeks being somewhat dampened by the ongoing public health challenges posed by the coronavirus spreading in China (and beyond). Against this backdrop, the US earnings season is in full swing.
While it’s fairly early days yet (around a fifth of the S&P 500 have reported results), fundamentals continue to remain reasonably solid: roughly 62% of companies have reported revenues that met or exceeded consensus expectations, while that number rises to 77% at an earnings level.
Source: Morgan Stanley
Source: Morgan Stanley
While it’s always worth taking quarterly earnings with a pinch of salt, the general trend reinforces the view we’ve had since August last year: things are not quite as dire as headlines make them out to be.
Of course, markets are forward-looking, so much of the devil lies in the details. Broadly speaking, companies are issuing guidance for 2020 that is cautiously upbeat, though tempered by some prudence given the unknown timing and depth of the impact that the coronavirus outbreak in China may have. Given that China is a major source of growth for many companies, it’s worth unpacking that in some more detail.
On the Apple earnings call this morning, CEO Tim Cook was forthright and helpful in addressing questions on the issue.
“With respect to [our] supply chain [in China], we do have some suppliers in the Wuhan area. All of these suppliers, there are alternate sources, and we’re obviously working on mitigation plans to make up any expected production loss. We factored our best thinking in the guidance that we provided you.
With respect to supply sources that are outside the Wuhan area, the impact is less clear at this time. The reopening of those factories after Chinese New Year has been moved from the end of this month to February 10, depending upon the supplier location. And we’ve attempted to account for this delayed start-up through our larger range of outcomes […] mentioned earlier.
With respect to customer demand and sales, we’ve currently closed one of our retail stores and a number of channel partners have also closed their store fronts. Many of the stores that remain open have also reduced operating hours. We’re taking additional precautions and frequently deep cleaning our stores as well as conducting temperature checks for employees. While our sales within the Wuhan area itself are small, retail traffic has also been impacted outside of this area across the country in the last few days. And again, we have attempted to account for this in our guidance range that we’ve provided you.”
The guidance referred to by Mr. Cook is for Apple to generate global revenues between $63bn and $67bn next quarter, implying year-on-year revenue growth of between 8.5% and 15.5%. With Apple likely joining the 5G smartphone market later in 2020 – and seeing strong demand for its wearable devices, such as the Apple Watch and the recently launched Airpods Pro wireless headphones – there is every likelihood of the company being able to deliver mid-to-high single digit sales growth over 2020. Combined with some margin expansion (partly driven by a shift to Apple’s more profitable Services business) and a healthy capital return programme, there is very high likelihood that Apple will grow its cash flows at a healthy clip, despite all the uncertainty out there.
This trend of strong results combined with cautious guidance seems to be an early theme in management feedback. Starbucks CEO Kevin Johnson and CFO Patrick Grismer alluded to the same, saying:
“Given the strength of our Q1 results, we had intended to raise certain aspects of our full year financial outlook for fiscal 2020. However, due to the dynamic situation unfolding with the coronavirus, we are not revising guidance at this time. […] We would have raised guidance on operating margin and for EPS on the strength of our Q1 results […] but given the uncertainty of the coronavirus situation in China and its impact to our near term results, which we expect to be temporary, we felt it was best to defer any change to our guidance until we had better visibility to full year results including the impact.”
In both cases, the benefits of capable management teams with years of on-the-ground operating experience should provide some comfort to investors that businesses can weather any near-term disruptions.
In summary, the US Q4 reporting season has started constructively. We will get more clarity on this trend over the next few days, particularly as some of the mega-cap technology names report.