With over three quarters of S&P 500 companies having reported, Q1 profits were on pace to grow by more than 10%. But markets have been less than impressed. Kim Parlee speaks with Damian Fernandes, Portfolio Manager, TD Asset Management, about equities that may weather the macro headwinds.
Damian, it's always great to have you with us. Good to have you on the program. Can you tell me just what you're seeing so far? Any common themes you're hearing from companies at this point?
- Thanks, Kim. It's great to be on. And I liked what you said initially. You said earnings are up 10%, and that's accurate. 80% of the S&P's reported earnings up about 10%. But interestingly, revenues, top line, is up 12. So when you think about that, the top line is growing 12, but earnings are growing 10.
So what's really happening is you're seeing costs-- margin degradation. Costs are growing faster than earnings. And I think if there's a story I could put together for so far what's happened, it's that we're actually finally seeing inflationary cost pressures, and that's affecting these companies in the US, and that's weighing on the sentiment.
- Interesting. I know you brought a chart here. I want to bring it up. We've just got to take a look here. And the title is "Hotel Gyms are Greater Than Home Gyms." Tell me a bit about this one, Damian.
- Yeah. It's tongue in cheek, and it's related to the earnings, right? And the chart is really, like, if you had $100 and you bought Hilton and you bought Peloton back before the pandemic, you can see, of course, the companies that benefit from the pandemic. So the earnings, revenues from the stay-at-home winners massively accelerated.
And then they've somewhat-- in the last few months, quarters, they've collapsed, the fundamentals for those businesses that have benefited from lockdowns, from stay-at-home. And conversely, Hilton just reported yesterday, and it is basically back. They said, by Q3, revenues for every average room will be back to the same levels as they were in 2019.
They reinstated their dividend. And so Hilton, you see themes are tied to reopening. They're tied to, you know-- not tied to these lockdown things. It's actually benefiting through earnings. And companies that for the last few years-- think about Netflix and the reaction to Netflix, or even Amazon, right? These companies that were really COVID lockdown winners, they're seeing some real challenges to this earnings season. Conversely, companies that are seeing a re-acceleration on reopening, those companies are actually benefiting in these earnings.
- Well, when you take a look at that filter, I guess the ones that are benefiting from reopening and also maybe those who are weathering inflation a little bit better than others, who's on your radar? What are you seeing there?
- Well, look, when we think about this-- for us, when we think about investing in high-quality companies, we generally want to see industry leadership. We want to see ties to secular trends. We want to generally see, on this earnings season, earnings growing faster than revenues.
One of the companies that I really liked that demonstrated this was Visa. Visa is tied-- a good chunk of Visa's revenues there are from cross-border transactions, from people going on vacations in different countries and using their Visa cards. They said cross-border transactions are back to 90% of levels they were pre-pandemic, and it's going to be 100% by September.
Visa did 25% revenue growth, 30% EPS growth. So unlike what I was talking about at the aggregate level, Visa actually saw margin expansion. So the market's really volatile right now, and it's kind of painting all these companies with the same brush. Visa's a technology company. Technology is under pressure.
But the underlying fundamentals are so much stronger for some of these businesses. They are more benefiting from the current outlook. I call it consumer revenge spending. Everyone being locked in for the last two years now wants to go on vacation. That's the most profitable part of Visa's business. They're benefiting. They reaffirmed guidance.
KIM PARLEE: Yeah.
- I was just going to say-- no, and it's a great-- it's a compelling story. But I'm going to ask you to play devil's advocate on Visa, too. I mean, would there be any concern about just economic growth? What's the bear case on Visa?
- Yeah. So there's almost like a misnomer. And we had Powell on today, and he also said this. And I know your earlier guest mentioned it. Economic growth is still really strong. The debate for markets right now is who's strong, and is the Fed going to have to over-tighten?
Visa isn't really tied to this, because I think the consumption spend that Visa is going to benefit from, a return to normal, just digitization of cash, that's a secular trend. People are using less cash and more of plastic to pay for payments, whether it's goods or services. It benefits with secular tailwinds. Plus it has the added bump from people returning to consumption activities they didn't do before-- vacationing.
And so Visa reiterated guidance. We're talking about double-digit earnings per share growth for this year, tied to secular trends. These are the kind of businesses that we like.
- Damian, I hate to do this. I've only got 30 seconds, but can you just tell me what are some of the key things you're watching for the back half of the year?
- Well, the back half of the year, the most-- we talked about earnings so far. A lot of the earnings expectations are built on a back half recovery. People are expecting earnings to grow faster in Q3 and Q4 than they did in Q1 and will do Q2.
I don't think, just realistically, what's happening with markets and commodity prices-- the Fed tightening, the geopolitical risk-- I don't think that's feasible. So what I'm watching for the back of the year is how much do those earnings have to come down.
The market's already corrected 13%, 14% before today's move. Is that justifiable to show that earnings are much more rebased and are a level where people are comfortable, that you won't have this big negative revision? That's what I'm watching, Kim, the second half of the year.
- Damian, thanks so much for joining us.
- Always a pleasure.