Weekly Wisdom – February 8, 2024

By Hightower Great Lakes on February 8, 2024

Halfway Through Earnings Season

We are roughly halfway through the fourth quarter of S&P 500 earnings season and results have been encouraging with 4.2% earnings growth y/y. 79% of the companies that have reported have beaten earnings expectations and 16% missed expectations.

The energy sector has recorded the highest beats rate at 90%, and yet has underperformed the S&P 500 by 4% so far year-to-date. The communication services sector has produced the highest earnings growth rate at 47% and is outperforming the S&P 500 by 8.5%.

It’s a long year, but seeing solid results is not a surprise with the economy growing at a 4% level and inflation being less of a headwind.

Company margins have also been a worthy callout with higher productivity, solid pricing power and lower inflation levels. We’ve called out the margin potential several times and believe it will continue to be a positive tailwind for companies. 

Consumer Tidbits

Amazon (AMZN) and McDonald’s (MCD) reported during the last week. These two leaders in the consumer discretionary sector together account for over 30.6% of the entire XLY index.[1]

Long-time readers know that we highly value the U.S. consumer, as their spending contributes to over 70% of U.S. GDP. A strong U.S. consumer equals a strong economy. The tight labor market has been the key facilitator of consumer strength.

Both companies reported earnings per share (EPS) and revenue growth versus Q4 2022 as well as solidified plans for growth well into the future. Amazon had a stellar quarter, showing revenue growth across all segments with increased operating profitability.

A quick look at the segment numbers: North American Retail +13% y/y, International Retail +17% y/y, AWS +13% y/y, Advertising +26% y/y, Subscription Services +14% y/y, Third Party Seller Services +19% y/y. As you can see, Amazon is firing on all cylinders.

The operating margin beat was a key contributor to the success of the report, which is a function of a major change that Amazon made over the last year.  

Operating Leverage Tutorial

This is a story that dates to early last year when Amazon decided it was time to reorganize its regional distribution network. It changed its U.S. retail strategy to go from a national hub to eight distinct, strategically placed regional hub networks using its data analytics tools.

This move made each regional hub more efficient on its own, thus strengthening the entire network. This gave Amazon operating margin leverage which translated into 3233.33% EPS growth y/y.[2] Operating margins were 7.8% and up 600 bps y/y and beat the consensus estimate of 6.1%.

Chart 1: Overview of Amazon’s Eight Regional Hubs [3]

Amazon is clearly showing an inflection in its retail business which we think will drive earnings growth for the next few quarters, if not years. Another strong segment came from its cloud division, AWS. It is the industry leader in cloud services and commands over 31% market share.[4]

AWS sales rose 13% y/y, with the Q4 backlog up 17% y/y. It benefited from cost optimizations diminishing as it continued to scale the cloud business. The pace of new deals has mainly accelerated as it further penetrates its customer base with key companies such as Nvidia (NVDA) and Salesforce (CRM).

Amazon is also progressing in multiple areas for generative AI. Stay tuned for Amazon to roll out ‘Rufus,’ an expert shopping assistant trained in Amazon’s product catalog and information across the web to help customers facilitate product discovery and trends. ‘Rufus’ will be rolled out over the coming weeks.

McDonald’s also reported earnings that featured EPS and revenue growth. Comparable store sales came in at +4.3%, driven by traffic gains in the U.S. and broad strength in other key markets such as the United Kingdom, Germany and Canada.

A key inflection point for McDonald’s has been its return to positive U.S. traffic after it experienced a slight miss in Q3. McDonald’s is also seeing strength in virtual traffic, as its loyalty app grew 45% y/y for the full year. Its digital experience has been the main driver of traffic and transaction growth and will help profitability over the next several years.

Operating margins also came in better than expected, pointing at +45.9%, 70 basis points better than the estimate and over 230 basis points higher than Q4 2022. McDonald’s should continue to experience strength in sales as it looks to expand its U.S. footprint over the coming years; it predicts this will give a +2% comparable sales boost in 2024.[5]

The strong U.S. consumer continues to drive earnings growth for companies such as Amazon and McDonald’s. We will keep you updated when more information becomes available.

Aramco Changes Course

Switching gears to the energy market and the sector news of the year. Saudi Aramco (ARAMCO), Saudi Arabia’s national oil company, abandoned its plan to boost its crude oil output capacity. The company’s original plan was to expand its sustainable capacity to 13 million barrels per day (mb/d).

Currently, Saudi Aramco produces only 9 mb/d due to its OPEC+ related production cuts, but has the capacity for 12 mb/d. This news was a big surprise to investors considering the national oil company was on record as of late suggesting otherwise.[6]

Oil services companies fell on the news, especially those with large international exposures. SLB (SLB) is an example of one of these oil service providers that has a large international footprint as it derives 80% of its revenue in this geography.

The company fell over 7% on the day of Aramco’s announcement. SLB has an approximately 8% revenue exposure to Saudi Aramco, and the national oil company is SLB’s largest customer.

About 80% of the capital that Aramco will be spending from 2023 to 2025 is focused on maintenance and gas-related projects, not expanding crude production. Therefore, estimates project the change of plans from Saudi Aramco to only impact SLB’s EBITDA by around 2% for the duration of the cycle.[7]

The stock is historically undervalued when looking at its current forward enterprise value to EBITDA multiple of 8.3x compared to its five-year average of over 10x.

Chart 2: 2024E National Oil Company Capex[8]

Overall, companies continue to grow earnings and outperform expectations driven by a resilient U.S. consumer, as we have seen thus far. Amazon and McDonald’s are just the beginning. We will see reports from the big box retailers and the rest of the consumer discretionary index over the coming weeks.

There are still plenty of opportunities in the market to find value for these strong earners. The continuation of earnings strength can propel a new cycle in the U.S. economy.

Sometimes an unexpected or overdone downturn in a stock can provide a favorable entry point. We thought this was the case last week when SLB experienced an exaggerated decline on the Saudi Aramco news.

Thanks for reading this week. We will be back to fully recap Q4 earnings season after all companies have reported.

Click here to read last week’s Weekly Wisdom (2/1).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

---

[1] Source: FactSet. As of February 5,2024.

[2] Source: FactSet. As of February 2, 2024.

[3] Source: AmazonScience. As of July 24, 2023.

[4] Source: CRN. As of February 2, 2024.

[5] Source: CNBC. As of February 5, 2024. 

[6] Source: Fortune As of January 30, 2024.

[7] Source: Goldman Sachs As of January 31, 2024.

[8] Source: Morgan Stanley. As of January 29, 2024.