Analysts Off the Mark on Energy Earnings

 | May 12, 2017 | 3:40 PM EDT
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Energy for a strong America! I had the jingle running through my head earlier today. Thanks to Google, I was able to identify it as an Exxon (XOM) commercial that aired circa 1979. I think it was on during Monday Night Football, as that was pretty much the highlight of my week as an 8-year-old. 

In any event, I was reminded of that annoyingly catchy jingle while perusing his week's FactSet Earnings Insight. FactSet's analyst John Butters and his team put together a weekly compendium on earnings for the S&P 500 that I find indispensable. Earnings for the S&P 500 in the first quarter of 2017, as you are probably aware, posted the highest year-on-year growth in 5½ years. Butters has that figure pinpointed at 13.6% with almost all of the 500 having reported, and clearly it was a better-than-expected season as expectations called for a 9% gain as we entered the quarter. 

All of us who follow earnings results knew energy companies would be a huge swing coming into the quarter. By Butters' figuring, the year-on-year change was on the order of $10 billion. FactSet's figures had the energy sector of the S&P 500 posting a $1.5 billion loss in aggregate in the first quarter of 2016 and a swing to a positive $8.5 billion in profit in the first quarter of 2017. So, it's not meaningful to post a year-on-year comparison, and without energy the S&P 500's year-on-year earnings gain would have been 9.4% instead of 13.6%. 

The interesting factor is not that energy and materials (the second-highest-growing sector in the S&P 500 with 17.8% aggregate EPS growth in the first quarter) drove year-on-year growth in earnings for the S&P 500, it's that analysts underestimated just how strong these earnings would be. 

Energy wasn't only the biggest contributor to year-on-year growth for S&P 500 earnings, it was also the biggest contributor to the better-than-expected growth rate versus earlier estimates. In fact, Buttters' numbers show the sector-weighted surprise for energy companies was a massive 21% in the first quarter. As someone who spent 11 years as a sell-side analyst, that is difficult for me to believe, but it speaks to the massive operating leverage energy companies have. 

God forbid if an analyst misses Apple's (AAPL) quarterly earnings by more than a penny or two, but first-quarter earnings predictions in the energy sector were massively low. That allowed many financial journalists to write "Big Oil is Back" pieces on the Friday that Exxon and Chevron (CVX) reported earnings, but really those two companies have done nothing to change their business models. 

As oil sits in a pocket of $45 to $50 a barrel in West Texas and natural gas prices rest safely in the range of $3.20 to $3.30 per million Btu, energy company earnings forecasting becomes much easier. It sounds perverse -- as so many other things do in this market -- but that might actually be a negative for stocks. More accurate sector-weighted earnings forecasts mean fewer chances for the talking heads on CNBC to yell "earnings are great." I would expect July and August's earnings season to be less eventful than the one that just passed. 

So, the opportunities for "earnings plays" next quarter will likely be in smaller, less-covered names. In energy that means stocks like Gastar Exploration (GST) , Torchlight Energy (TRCH) and Evolution Petroleum (EPM) -- all of which I have covered in recent columns -- should have more upside than the major integrateds like Chevron and Exxon. That's how I am playing it these days, and I'll keep following up on those names in future columns.

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