Surging oil prices might be sapping consumer enthusiasm, but they're doing wonders for the corporate profit picture. Excluding the energy sector, Wall Street's third-quarter earnings estimates call for year-over-year growth of 10.9%, according to Thomson First Call. Expectations outside of energy were lowered after companies from a variety of other sectors slashed their forecasts in recent weeks in the wake of hurricanes Katrina and Rita. Meanwhile, energy companies have quietly watched their stocks soar while analysts cranked up their quarterly estimates for the sector. Wall Street, which was expecting overall earnings growth of 21% from energy companies as recently as last month, now pegs it at 73%. "We typically don't see jumps that big in estimates during the course of a quarter," says Thomson First Call analyst John Butters. "You've got to go back a ways to find an improvement on that scale." Thanks to that spectacular rise, overall profits for the S&P 500 are expected to rise by 17.6%, up from the 16.8% pace set in the same quarter last year. That figure marks an increase from late August, before the hurricanes struck the Gulf Coast, when analysts were expecting a gain of 15.1%. Most people attribute the energy sector's success of late to the run-up in crude oil prices that has been a focus for market watchers this year and last. But crude has actually declined after a brief spike when Katrina made landfall in New Orleans. Since then, the biggest boost to energy companies has been gains in so-called crack spreads -- the spread between the price of refined oil products (gas, diesel, jet fuel or heating oil) and crude. That spread represents profit margins for refining companies. Fadel Gheit, an analyst with Oppenheimer & Co., estimates that average crack spreads for major refiners have increased more than 50% in the third quarter from the second quarter. Strains on the nation's capacity to refine crude oil are responsible for the jump, he says, and those strains aren't likely to abate anytime soon.
"President Bush said he would release crude from the emergency petroleum reserves, but we don't need more crude oil," says Gheit. "We need more capacity to refine crude oil, and it will take five years to build." While crack spreads and gas prices have soared in September, shares of Exxon Mobil ( XOM) have jumped 8% for the month. Shares of Chevron ( CVX) have gained almost 6% and ConocoPhillips ( COP) is up more 5%. "We expect overall U.S. processed refined products will be constrained throughout the remainder of this year, compared to similar periods in prior years," said ConocoPhillips in a recent statement assessing hurricane damage. Gheit says oil companies will feel some strain from the loss of production due to hurricane damage, but the storms would add up to a nice net gain. "These companies will make up more on higher prices on margin then they lost in volume," Gheit says. "At the end of the day, we need gasoline, jet fuel, heating oil and diesel. Our economy runs on these products, and without them we are cooked." With third-quarter reporting season just two weeks away, the downside of higher energy prices is beginning to show up elsewhere. No sector besides energy is expected to show a jump in its growth rate, except for telecom, which has a fairly minor influence on the overall numbers. Technology is headed for a slight gain, but other sectors have come down in varying degrees or stayed the same. Analysts expect materials to record the weakest showing for the quarter, a decline of 9%. At the beginning of the quarter, earnings for materials were expected to rise by 12%, but disappointments from the likes of Dow Chemical ( DOW), AK Steel ( AKS) and DuPont ( DD) killed the space. All the companies blamed oil prices for their respective shortfalls.
Consumer discretionary lays claim to the second-worst outlook among sectors. Wall Street expects 1% growth for the space, but if you pull Ford ( F), General Motors ( GM), Delphi ( DPH) and four other auto-parts makers out of the mix, the sector would be headed for an estimated 16% increase. High gas prices have made product decisions by Detroit's automakers look ridiculous, but signs are emerging that retailers are starting to feel the squeeze as well. With the S&P Retail Index down 5% in September, the sector has been hit by disappointing preannouncements from the likes of Wal-Mart ( WMT), Dick's Sporting Goods ( DKS), Family Dollar Stores ( FDO), CVS ( CVS), Ross Stores ( ROST), Limited Brands ( LTD), Hot Topic ( HOTT), Aeropostale ( ARO), Pier 1 Imports ( PIR), American Eagle Outfitters ( AEOS) and Yum! Brands ( YUM). Meanwhile, Thomson First Call has tallied a list of 19 companies that have warned of disappointments and pinned the blame on a rowdy hurricane season. The list includes Yellow Roadway ( YELL), Knight-Ridder ( KRI) and Estee Lauder ( EL). "This seems like a light number considering all the retailers and restaurants and other companies that do business along the Gulf Coast," Butters says. "In the next two weeks, we'll probably get quite a bit more commentary on the impacts of the hurricanes than we've got so far. We'll probably see more companies lowering expectations." On a brighter note, analysts predict the financial sector will be the second-strongest grower behind energy, thanks largely to promising results logged by brokerages, including Lehman Brothers ( LEH). The sector is expected to show 20% growth, but that pace would mark a sizable reduction from 25%, where estimates stood at the start of the quarter. The downside is largely attributable to pullbacks in estimates for insurance companies, like HCC ( HCC), who are expected to take hefty charges related to hurricane damage. All things considered, Gheit advises investors to stick with energy. "We remain bullish on energy stocks, especially domestic natural gas producers and in particular those with an onshore focus," Gheit says. "They are not as affected by the hurricanes."