Salient to Investors:
Bloomberg and Strategas Research Partners report the average S&P 500 company cut interest expenses to 2.39 percent of sales in the 12 months ended Sept. 30, the lowest since at least 2002. With borrowing expenses at record lows, companies are finding it harder to squeeze costs, causing profit margins to contract for the first time since 2009 and leaving investors more dependent on economic growth and corporate spending for equity gains in 2013.
Bears say projected revenue growth of 3.8 percent for S&P 500 companies in 2013 won’t be enough to increase profits without a decline in expenses. Bulls cite the 8.9 percent profit growth estimated in 2013, equity valuations at a 12 percent discount to the six-decade average, and an economic recovery as reasons companies will start to spend their $1 trillion in cash.
The S&P 500 P/E ratio of 14.5 is 12 percent below its average since 1954. Margins were 13.6 percent in Q3 2012 versus 8.3 percent in Q3 2009. Lower interest costs have helped profits climb for 10 straight quarters, surpassing analyst estimates every quarter in 2012. The average analyst expects earnings to increase 8.9 percent in 2013 and 12 percent in 2014. The average economist expects GDP to grow 2 percent in 2013 and 2.8 percent in 2014.
Nick Sargen at Fort Washington Investment Advisors says the consensus view is there’s little room for margin expansion,so profit growth must come from growth in the U.S. and global economy.
Timothy Ghriskey at Solaris says revenues need to accelerate to boost margins, which are driven by the economy.
Brian Barish at Cambiar Investors said cash levels and rising corporate spending on capital goods are signs that stocks are spring-loaded to rally should the economy match forecasts. Barich said valuations may help takeovers rise in 2013 as the opportunity for highly accretive cash-based M&A is substantial, and sees slow and steady profit growth.
Jason Trennert at Strategas in New York said margins have reached a level historically represented peaks, and doesn’t see the interest rate environment getting much more favorable. Trennert said the Street’s high EPS estimate for 2013 must be substantiated by margin expansion, strong top-line growth, or a combination of both – hard to see given peaking margins and 4 percent nominal GDP growth.