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Sales Slowdown Masked by Better-Than-Expected Earnings

Better-than-forecast earnings are masking weaker sales growth in the most recent quarter as U.S. companies including International Business Machines Corp. (IBM) improve margins to top estimates.

Sales rose an average 2.9 percent in the second quarter among 119 members of the Standard & Poor’s 500 Index that have reported results so far, the weakest since a decline of 9.6 percent in the third quarter of 2009, according to data compiled by Bloomberg. Only 42 percent of the reported companies have topped analysts’ estimates on sales, while 73 percent have beaten on profit, the data show.

The gap in results signals companies may hold off hiring and expanding until demand rebounds globally. Federal Reserve Chairman Ben S. Bernanke told lawmakers last week that progress in reducing unemployment may be “frustratingly slow” with joblessness stuck above 8 percent since February 2009.

“People are sitting on the sidelines right now waiting to see what happens,” Verizon Communications Inc. Chief Financial Officer Fran Shammo said in a telephone interview last week after the New York-based company reported in-line second-quarter profit and sales. “This isn’t helping with growth, so I think we will continue to mosey along here in the states.”

Earnings Drop

Analysts have lowered predictions for profit and revenue in recent months. For earnings, they estimate a 1.6 percent decline on average among all S&P 500 members after anticipating a 0.5 percent increase in May. Revenue may rise 1.8 percent on average, down from a 3.7 percent estimate in May.

U.S. consumer confidence and equity valuations are diverging the most in 17 years as the economy and profit growth leave stock prices behind. The S&P 500 has traded at an average price-earnings multiple of 13.9 this year, 0.18 times the mean level of the Thomson Reuters/University of Michigan final index of consumer sentiment, according to data compiled by Bloomberg. The gap is the widest since 1995, when the S&P 500 gained 34 percent for its biggest annual rally of the last five decades.

“The world is profoundly underinvested in U.S. equities,” said Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida. His firm oversees $350 billion. “We’re in a confidence crisis, so Mr. Market is unwilling to put a big, higher P/E ratio on it.”

IBM, GE

IBM raised its full-year earnings forecast last week, even after second-quarter sales fell short of analysts’ estimates. The Armonk, New York-based company has been shifting away from hardware and services to focus on more profitable software, where pretax margins increased 2.7 percentage points.

General Electric Co. (GE) told investors July 20 that margins will start to expand in the third quarter. Second-quarter adjusted earnings beat estimates by 1 cent a share, while sales fell short.

For many companies, growth has slowed across all regions. Nike Inc. (NKE), semiconductor maker Advanced Micro Devices Inc. (AMD) and casino operator Wynn Resorts Ltd. (WYNN) are among those that pointed to weakening demand in China in recent weeks when they reported lower-than-expected sales or cut forecasts.

China is in the midst of its slowest expansion in three years, fueling investor concern that the country’s growth isn’t enough to counter a recession in at least seven of euro-area countries and sluggish spending in the U.S. The International Monetary Fund projected last week that the global economy will expand 3.5 percent this year. It trimmed its 2013 forecast to 3.9 percent from 4.1 percent.

China Slowdown

“The engines of growth that kept the world economy growing are definitely slowing,” said David Kolpak, an analyst who helps manage about $20 billion at Victory Capital Management in Brooklyn, Ohio. “With the slowdown in China, the lack of recovery in the U.S. and Europe getting worse by the day, it’s not too surprising to see demand for just about any kind of consumer or industrial product is not very healthy.”

Nike, the world’s largest sporting-goods company, posted fiscal fourth-quarter revenue of $6.47 billion last month, trailing the average estimate of $6.51 billion of analysts. Puma SE (PUM), Europe’s second-largest sporting-goods maker after Adidas AG, last week cut its 2012 forecast and said it will close stores after business slowed in the first half.

Unpredictable World

Wynn, billionaire Steve Wynn’s Las Vegas-based casino company, reported second-quarter revenue slumped 8.3 percent as high-stakes gamblers in Macau curbed spending because of China’s slowing economy.

“This is a world in which no one can predict tomorrow,” Wynn told analysts on a July 17 conference call. “China, incidentally, is more stable than anyplace else. Europe and the United States are tricky.”

U.S. retail sales unexpectedly fell for a third month in June. The 0.5 percent drop, reported last week by the Commerce Department, exceeded the most pessimistic forecast in a Bloomberg News survey of 81 economists.

In one of the few bright spots, General Motors Co. (GM), Ford Motor Co. (F) and Chrysler Group LLC reported U.S. auto sales for June that surpassed analysts’ estimates. Sales accelerated to a 14.1 million seasonally adjusted annualized rate, according to a e-mailed statement from researcher Autodata Corp.

Holding Off

In luxury, Burberry Group Plc (BRBY) dragged stocks lower this month after reporting sales that missed analysts’ estimates, fueling concern that Europe’s debt crisis and slowing growth in China are finally taking a toll on demand for high-end goods. That followed Tiffany & Co. (TIF) cutting its full-year forecast in May after revenue fell at its New York flagship store, a shopping destination for overseas visitors.

Hengdeli Holdings Ltd. (3389), the retail partner of Swatch Group AG in China, said this month that demand for its luxury watches has waned amid the country’s weaker economic growth. Sales growth for high-end watches has slowed to a single-digit percentage in recent months, according to Vice President Tan Li.

“If consumers are uncertain about the future, they may put off purchases of big ticket items,” Tan said in an interview on July 9.

Intel Corp. (INTC), the world’s largest semiconductor maker, scaled back its annual sales forecast last week as personal- computer demand fails to rebound among consumers in the U.S. and Europe. Rival Advanced Micro Devices disclosed second-quarter revenue unexpectedly slumped 11 percent from the first quarter after previously forecasting growth of as much as 6 percent.

Nobody Knows

The miss shows how difficult it is for companies and analysts to accurately predict revenue. Slowing sales and currency fluctuations forced Procter & Gamble Co. (PG), the world’s largest consumer products company, to cut profit forecasts three times in 2012. Analysts project revenue will fall 3 percent in the fourth quarter ended in June, the first decline in 2 1/2 years. Johnson & Johnson (JNJ) and Philip Morris International Inc. (PM) both reduced full-year forecasts.

“Nobody really knows how to call this economy,” said Michael Ward, chief executive officer of CSX Corp. (CSX), the biggest eastern U.S. railroad. He spoke in a July 18 interview after reporting second-quarter profit rose, helped by lower fuel costs. Sales fell, trailing analysts’ estimates. “There are so many moving parts out there that it’s hard to predict.”

McDonald’s, the world’s largest restaurant company, reported a sales gain of less than 1 percent today to $6.92 billion, its weakest performance since the third quarter of 2009. Analysts had projected $6.96 billion. Earnings of $1.32 a share trailed the average analysts’ estimate of $1.38.

PepsiCo Inc. (PEP) and Caterpillar Inc. (CAT) are also among companies projected to report their worst quarterly sales results in more than two years, according to data compiled by Bloomberg.

“We’re going to keep seeing lackluster results in sales, especially by companies that have a global presence,” said Diane Garnick, chief executive officer of Clear Alternatives LLC, a New York-based asset management firm. “Not as many people are spending money on discretionary items.”

To contact the reporter on this story: {Chris Burritt} in Greensboro at cburritt@bloomberg.net

To contact the editors responsible for this story: Jennifer Sondag at jsondag@bloomberg.net; Robin Ajello at rajello@bloomberg.net

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