Tesla beats estimates, while October PMIs are on the menu
Earnings season is in full swing, which has given us time to assess the impact of rising prices and tight global supply chains on corporate bottom lines. For now, the overall message is that companies are managing very well with inflation concerns. From a broad perspective, this means that we may have seen enough earnings power on equity markets to withstand the various economic headwinds that we are witnessing. To put the earnings figures from the S&P 500 into some context, 80% of companies that have reported Q3 results so far have reported a positive surprise on earnings, with 83% of companies that have reported their results delivering a positive revenue surprise. Added to this, the 12-month forward P/E ratio for the S&P 500 is 20.3, which is above both the 5-year and 10-year averages, according to data compiled by FactSet. This is significant, as it suggests that analysts are not pricing in for a sell-off in equities, even at these richly valued levels, any time soon.
Vroom, Vroom, Tesla smashes earnings estimates
Tesla released earnings overnight, and the news was good. It reported record revenue and profits in Q3, it produced 237,823 vehicles in Q3, which is an annual increase of over 60%, while it delivered more than 241,000 vehicles, which is an increase of 70%. Earnings per share were $1.86, vs. $1.59 expected, while revenue was $13.76bn, vs. $13.63 bn expected. The company posted $1.6bn in GAAP income, which is only the second time that it has reported income over $1bn, it also reported $2.1bn in non-GAAP income for the quarter, and operating margin was 14.6% of sales, which was stronger than analysts had expected. Gross margin was also over 30%, which is a record for at least the last five quarters. Tesla also generated over $800mn in revenue from its energy and solar business, and $894mn from its services, repair and parts and insurance business units.
The future looks good for EV stalwart
Overall, these are a strong set of results for Tesla. It suggests that its production line issues from the past could be behind it. Concerns about production quality, particularly from Tesla’s China factory, also seem to be resolved. The company’s battery factory in Germany is also on schedule and it is currently in the testing phase. Tesla’s investor deck that was released with Q3 earnings, also pointed out that a “variety of challenges” including semiconductor shortages, congestion at ports and some rolling blackouts “have been impacting our ability to keep factories running at full speed.” However, this has not stopped the company from reiterating its prior guidance that it expects to achieve 50% average annual growth in vehicle deliveries over a multi-year horizon. Thus, while Tesla name-checked the various issues that could hurt its vehicle production, the fact that it has issued decent forward guidance means that 1, it must be able to withstand these headwinds, and 2, that it has the production capacity available to mitigate these concerns.
Forward guidance is the key driver of stocks during earnings season, but with such an uncertain economic environment, we will be watching what companies say about their future earnings even more closely than usual. From a share price perspective, Tesla’s share price remains close to a record high, and it fell slightly after the earnings release. However, October has been a good month for the Nasdaq and other stock markets so far, thus, if upside momentum can be maintained then we think that Tesla could make an attempt at fresh record highs.
UK banks unlikely to follow US, but FTSE 100 looks good for now
Elsewhere, European indices are also performing well. Although it was fairly mixed on Wednesday, the FTSE 100 has continued to rise this week even with the sharp readjustment in UK interest rate expectations, with the first rate rise due to happen next month. UK banks will start to deliver earnings this week, and due to the relatively large size of the financial sector in the FTSE 100, these will be watched closely. Analysts will want to know if UK banks can match their peers in the US, who had a stellar Q3 season on the back of deal-making revenues. Barclays is the only major UK bank that has a large trading arm these days, thus its results will be watched closely. Elsewhere, the market will be watching to see whether lower demand for credit and mortgages, caused by the end of the stamp duty holiday in the UK, will hurt banks’ revenues, especially for Lloyds and NatWest. The rapidly rising UK yield curve should boost banks earnings, as it improves Net Interest Margins (NIM). However, if loan growth is weak, then we cannot see how UK banks can benefit from higher NIM levels. Also, UK banks are not releasing as many loan-loss reserves as their US counterparts, due to fears about future defaults in the UK on the back of rising Covid cases and the end of government support schemes such as the furlough scheme. Overall, we do not think that UK banks will perform nearly as well as their US counterparts, however, the continued strength of commodity prices, should help the FTSE 100 as the energy sector could carry the overall index higher as long as market momentum remains to the upside. We think that the high from February 2020, above 7,240, is still achievable for the UK index.
What to watch for in PMI reports for October
As we move to the end of the week, the market will be watching the first reading of October PMIs that will be released on Friday. The market is expecting moderate declines in Europe the UK and the US; however, indices are still expected to remain at decent levels of expansion historically. If we see better than expected readings for October, this could be a powerful driver of stock markets and risk sentiment generally for the rest of this month. We will be watching the UK service sector PMI closely, the market expects a reading of 54.5, down from 55.4 in September. If this comes in stronger than expected, then it would be an indication of UK consumer strength even in the face of potential interest rate increases. We will also be watching US manufacturing PMI, which is expected to fall a touch to 60.3 from 60.7 in September, however this would still be a high level. Right now, corporate earnings reports suggest that the manufacturing sector remains strong in the US, if the economic data supports this sentiment then we could find that the narrative shifts, with a more positive narrative developing as we move into the last few months of the year, which could be good for risk sentiment.