Inflation Pressure Is Real and Other Earnings Nuggets
(Bloomberg Opinion) -- On this busy day for industrial earnings, it’s clear a recovery is taking form but it’s also clear that the pandemic is still very much a thing. Traditional industrial markets — including automotive parts and equipment for elective health-care procedures — are bouncing back, but that’s causing raw material, logistics and labor costs to rise. The hard-hit aviation sector is showing some early signs of improvement as more planes return to service and need maintenance work, but it’s slow going for engine makers General Electric Co. and Raytheon Technologies Corp. Meanwhile, businesses that benefited from the pandemic — such as 3M Co.’s N95 masks and United Parcel Service Inc.’s delivery services — are continuing to boom as the virus lingers and certain Covid habits prove sticky.
Amid all of these conflicting signals, this group of industry bellwethers largely declined to commit to a more optimistic outlook for the rest of the year. Raytheon was the only company to raise its full-year earnings and sales guidance, and the move was more incremental than game-changing. And so investors were forced to read between the lines. Here are my takeaways from Tuesday’s batch of industrial results:
Americans Still Like Buying Stuff Online: More than a year into the pandemic, UPS analysts are still getting caught off guard by the sheer magnitude of pandemic online-shopping habits. Revenue for the three-month period ended in March climbed to $22.9 billion, up nearly $5 billion from a year earlier. To put that in context, that means UPS gained more than an Under Armour Inc.’s worth of revenue over the course of the pandemic. What’s most impressive about this surge is the degree to which it’s continuing to boost UPS’s bottom line. The process of delivering individual packages to consumers’ doorsteps is naturally less profitable than ferrying truckloads of goods to offices, but limitations on freight capacity because of parked commercial aircraft and a captive audience of retailers desperate to move product out the door have allowed UPS and rival FedEx Corp. to charge more for their services. There were questions among analysts as to how sustainable these pricing gains would be as the vaccine rollout gained momentum and the economy reopened. Well, on Tuesday, UPS reported its widest adjusted operating margin in five years.
The comparisons will get tougher as the year goes on but the narrative for this company has clearly shifted in a more permanent way under Chief Executive Officer Carol Tome’s “better not bigger” strategy. It’s a bit surprising that after a such a steady string of positive earnings news, UPS still doesn’t feel comfortable giving guidance for the full year. The company blamed this on “continued economic uncertainty.” To take a more cynical view, giving formal guidance might help analysts more accurately estimate quarterly results and limit the opportunities for such eye-popping surprises on earnings day. Why risk tripping up a stock price that keeps setting new records if you don’t have to? Case in point, UPS shares climbed more than 10% on Tuesday.
Cost Pressures Are Real: 3M beat analysts’ estimates for first-quarter earnings and generated broad-based growth across all of its businesses. Sales of its N95 masks and other respirators rose $190 million from a year earlier, but the company also saw growth in roofing granules, industrial adhesives, electronic components and certain health-care products. And yet, 3M left its guidance for the rest of the year unchanged. It cited a “fluid and uneven” recovery but also rising costs. The company now expects as much as a 50-cent hit to its annual earnings per share from rising raw-material and logistics costs. Only about a month ago, Chief Financial Officer Monish Patolawala had signaled the impact would be more in the range of 20 cents, underscoring how fast-moving these cost dynamics can be. The company is working to offset these pressures by increasing prices for customers, exploring alternative sourcing options, improving its operational efficiency and trying to plan better for the whiplash effect of pandemic demand swings. But the benefits of these actions won’t show up until later in the year, so 3M predicted rising costs would shave as much as 125 basis points off its operating margin in the second quarter. That wasn’t exactly a soothing message for investors who are already jittery about inflation. 3M shares fell about 3%.
There’s Only One GE : The highlight of GE’s first quarter was the company’s announcement that it would sell a majority stake in its GECAS jet-lessor business for total consideration of more than $30 billion and wind down GE Capital as a separate entity as a result. The deal helps raise money to pay off some of GE’s still-too-large debt load but the bigger goal is to simplify a company that somehow always seems to have idiosyncratic issues on earnings day. Unfortunately, this is easier said than done. That's how executives wound up spending a good portion of the earnings call talking about factoring — or the sale of accounts receivable to the financing arm in exchange for cash to help with short-term funding needs. GE largely discontinued this practice as of April 1 in preparation for a future when it’s less reliant on GE Capital. It will adjust out the resulting hit to its cash flow in future quarters but didn't do so in the first quarter and analysts were struggling to keep up with all of the moving parts. It's a temporary headache, but it clouds the argument that GE has put its old habits of obfuscation behind it and is just a regular industrial company.
Amid all the messiness, GE elected to keep its free-cash-flow guidance for the full year unchanged and its first-quarter showing on this front was a bit light relative to analysts' estimates. On the bright side, GE’s profit margins in the all-important aviation division offered some good news. While the 12.8% segment margin was about 200 basis points worse than a year ago, it represented a 320 basis-point improvement from the fourth quarter as cost cuts took hold. Raytheon just barely eked out a profit in its rival Pratt & Whitney jet engine unit, although that was more than offset in investors’ minds by the news that it’s boosting its share buyback to about $2 billion this year. There aren’t many other companies in the aerospace industry that have the financial wherewithal to even think about repurchasing stock right now, let alone increase their target this early in the year. GE shares fell about 2.5%, while Raytheon’s stock climbed about 2%.
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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