Earlier this week, The Wall Street Journal ran an article that was very near and dear to my heart because it focused on something that I see as incredibly important when examining and evaluating potential recommendations for my Growth & Dividend Report. The article was aptly titled “The Number to Watch This Earnings Season.”
Bottom-line earnings expectations have been shrinking for the last several months as the market reassesses the impact of the slowing global economy and negative moves in a number of commodities, particularly oil. In recent weeks, however, we’ve seen a growing number of companies across a variety of industries negatively preannounce their September-quarter results, if not cut their outlooks for the December 2015 quarter and for all of 2016. Worse yet, based on several data points out this week, we know things are not getting any better. Yesterday’s September Trade Balance Report for China showed that in yuan terms, China’s imports plunged 17.7% year over year in September with the decline accelerating from the 14.3% year-over-year decrease in August. Taking a somewhat longer view, September marked the 11th straight month of declines. September exports from China also fell 1.1% in yuan terms.
This morning, compound semiconductor capital equipment company Aixtron (AIXG) cut its 2015 revenue guidance to €190-€200 million from its prior guidance of €220-€250 million. The company laid blame on a postponement of shipments to a large Chinese customer that were planned for delivery in 2015. Finally, (remember the saying about things coming in threes?) the International Energy Agency (IEA) cut its global demand growth forecast for oil. In the wake of recent downgrades to the global macroeconomy, the IEA now sees global demand growth slowing from its five-year high of 1.8 million barrels per day (mb/d) in 2015 to 1.2 mb/d in 2016.
Despite all of this data, CSX Corp. (CSX) was able to deliver an earnings per share (EPS) beat last night when it reported its September-quarter results. That EPS outperformance occurred even though railcar loadings fell during the September quarter… and the company’s revenue dropped 9% year over year in the same quarter… and both Operating Income and Earnings Before Interest and Tax dropped year over year… and, yes, Net Income for the September quarter also dropped year over year.
How did CSX deliver a bottom-line beat?
Thanks to the beauty of financial engineering that includes stock buybacks, CSX was able to shrink its outstanding share count year over year by 1.7% to 982 million shares from 999 million in the September 2014 quarter. While it may not seem like much, that drop in the share count along with a lower tax rate year over year enabled CSX to deliver earnings per share of $0.52 per share for 3Q 2015, surpassing expected earnings of $0.50 per share and the $0.51 per share the company delivered in 3Q 2014. If CSX has the same tax rate and the same share count as it did in 3Q 2014, its bottom line for 3Q 2015 would have looked more like $0.50 per share to produce an inline quarter.
Those aren’t the only financial shenanigans to be had. For example, towards the end of last week, retail giant Macy’s (M) announced the sale of the top four floors of its Seattle store, netting the company about $60 million in pre-tax profits. The announcement of the sale indicated that it already was in the company’s guidance. But in looking back at previous guidance commentary, let’s just say it was less than clear. Maybe it was, maybe it wasn’t. However, here’s the thing — such a sale is not a part of a retailer’s regular and ongoing business activity. As such, those profits should be treated as a one-time gain. In looking at the company’s regular or “core” business, we would exclude such a gain because it masks the true operating performance during the quarter.
That’s why I tend to focus in on margins — both gross margin, which is a company’s gross profit divided by its total revenue, and its operating margin, or operating income divided by total revenue. I scrutinize both. But of the two, I will dig far deeper into the operating margin trend as it better reflects the company’s cost structure, trends within that cost structure and profit per incremental dollar of revenue. Despite the year-over-year decline in revenues and profits that I described above for CSX, its operating margin for the September 2015 quarter came in at 31.7%, up from 30.3% in the year-ago quarter. That tells me CSX not only had a tight handle on its costs, but as the business (revenues) fell, it was able to manage its costs. It is a good sign that management is on top of its business and not asleep at the switch, which means CSX could be one stock to look at when the domestic economy rebounds.
In case you missed it, I encourage you to read my e-letter column from last week about protecting yourself during uncertain times in the market. I also invite you to comment in the space provided below my commentary.
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