So Far, There's Spring in First Quarter's Step

The upside surprises are way ahead after the first few days of earnings season.

Author:: Rebecca Byrne
Publish date:: Apr 17, 2002 4:42 PM EDT

Updated from 2:25 p.m. EDT

Corporate America is proving that it's not hard to beat drastically reduced earnings expectations, particularly when the economy plays along.

The first-quarter earnings season has only just begun, but it's already shaping up to be much better than anticipated, with scores of companies from autos to tobacco to semiconductors cruising past analysts' estimates.

"Expectations had been reduced to a level that made it much easier to beat," said James Oberweis, president and portfolio manager at Oberweis Asset Management.

Analyze This

As of Tuesday night, some 65 companies had beaten analysts' estimates for the first quarter, while 30 were on target and just 15 missed the consensus view. On Wednesday alone, a plethora of companies including

Merrill Lynch

(MER)

Ford

(F) - Get Report

Harley-Davidson

(HDI)

Nextel

(NXTL)

and

Philip Morris

(MO) - Get Report

had all surprised on the upside.

"In the aftermath of Sept. 11, we all got nervous," said Tobias Levkovich, an analyst at Salomon Smith Barney. "So all we did was drive down expectations."

But Levkovich notes that the rapid growth in industrial production has also helped companies exceed forecasts.

Industrial output rose 0.7% in March, the largest increase since May 2000, and productivity gains were widespread across most industries. Meanwhile, capacity utilization rose to 75.4%, the highest since August 2001.

"Historically, earnings trends move in tandem with industrial production," he said.

Cycling

Levkovich added that earnings typically begin to climb roughly two quarters after the economy starts to turn. GDP rose 1.7% in the fourth quarter of 2001 and is expected to jump more than 5% in the first quarter. "It is highly probable that the second quarter will be the first quarter of earnings growth," he said.

First-quarter earnings are currently expected to decline 10.7% from last year, and second-quarter earnings are slated to rise 8.3%. Third- and fourth-quarter earnings are projected to climb 29.2% and 42.8%, respectively.

The Fine Print

Few analysts would dispute that the economy has played an important role in driving earnings in the first quarter, but Oberweis says that the exclusion of charges related to an accounting change for goodwill amortization is also inflating some companies' reported earnings.

General Electric

(GE) - Get Report

, for example, declared that first-quarter profits rose 17% from the same period last year, although net profits actually declined when a $1 billion charge related to the new accounting rule is included.

And despite the recent crackdown on accounting gimmickry, some companies continue to take large special charges in order to meet or exceed estimates.

Motorola

(MOT)

posted a first-quarter loss of 20 cents a share but said it lost just 8 cents excluding special items such as asset writedowns. The company, which is known for repeatedly taking "one-time" charges, beat the consensus estimate of a loss of 12 cents.

Similarly,

Millennium Pharmaceuticals

(MLNM)

reported a first-quarter loss (minus a host of charges) of 22 cents per share. That beat the estimates by 2 cents a share.

"It's a very risky proposition for companies

to manipulate their earnings; if they are perceived to have opaque numbers or are playing games, the market will slam them," Levkovich said.

Elaine Hahn, president of Hahn Capital Management, said a number of companies bought back stock in the first quarter, which helped them to reduce outstanding shares and hit earnings targets more easily. "Stock buybacks have been pretty aggressive because companies have had a fair amount of cash," she said.

Among those buying back shares last quarter were Intel, Phil Morris and

Citigroup

In addition, several companies have taken aggressive cost-cutting measures to shore up their balance sheets. A slew of firms have reduced employee benefits, bonuses and other compensation and many have their slashed capital expenditures, which has helped to enhance the bottom line.

Of course, it hasn't all been good news. Several large blue-chip companies have been hammered recently after disappointing investors with below-par results.

General Electric fell 9% after missing revenue estimates and as investors asked questions about the quality of earnings. On Wednesday,

Boeing

(BA) - Get Report

plunged 7% after posting a profit of 75 cents a share, excluding charges, which missed estimates by a dime, and

IBM

(IBM) - Get Report

warned just last week that it expects to report earnings and revenue well below analysts' expectations.

Meanwhile, chief executive officers continue to temper expectations about the future, noting that spending patterns have not improved meaningfully.

Last night, Intel's chief financial officer Andy Bryant echoed "the recent views of Cisco, 3M Corp and a host of others that the worst is likely over but the best is still out there," said chief market analyst Larry Wachtel at Prudential Securities.