Top Gun FP Client Note: Breakfast At Tiffany’s
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. Here is this week’s.
There’s been an unprecedented decline in overhead costs.
– David Kostin, Equity Strategist, Goldman Sachs
You can not simply cut costs forever to have sustainable earnings. You need revenues to grow them over time.
– Dirk Van Dijk, Chief Equity Strategist, Zacks Investment Research
Last Friday before the market open, jeweler Tiffany’s (TIF) reported 2nd quarter earnings. Tiffany’s has 211 stores around the world including 88 in the Americas, 99 in Asia-Pacific and 24 in Europe. Worldwide same store sales were off 16% from the year ago period and US same store sales were off a whopping 27%. Earnings per share excluding a loan recovery and tax reserve adjustment were 41 cents – down 35% from the 63 cents a share it earned in last year’s 2nd quarter. However, the 41 cent EPS beat Wall Street analyst estimates for 33 cents and the stock soared 11.3% on big volume on Friday.
A deeper look at Tiffany’s 2nd quarter report shows that cost cutting is what enabled them to beat Wall Street’s reduced estimates. Tiffany’s reduced Selling, General and Administrative expenses (SG&A) by almost $40 million, a 13.8% decrease compared to the year ago period. That $40 million in reduced expenses boosted net income by 23 cents a share – far greater than the 8 cent a share margin by which they beat estimates.
Tiffany’s report is representative of the 2nd quarter earnings reports I’ve reviewed. Revenues have been weak across the board but companies have been able to beat lowered Wall Street estimates on the bottom line through greater than anticipated cost cutting. According to Goldman Sachs Equity Strategist David Kostin, SG&A expenses for S&P 500 companies plunged 6.4% in the 2nd quarter – far greater than the 0.2% drop during the last recession and the 4.1% drop during the 1991 recession.
All this cost cutting has made the bottom line look good for the current quarter, relative to expectations, but it isn’t sustainable. Companies need to spend money on employees, utilities, and all kinds of other day to day expenses in order to operate. At some point, you can’t cut anymore and in order to grow earnings you need to grow sales. Further, all this cutting has implications for the economy as laid off employees can’t spend as much, vendors and suppliers doing less business have to cut back, and so on and so on.
The 2nd quarter earnings season surprised Wall Street on the upside, fuelling the powerful rally since early July. It surprised me too. The July 13th Client Note was titled “The Bottom Line Is The Bottom Line”
and my basic premise was that ugly 2nd quarter earnings would throw cold water on the rally. It didn’t happen. But the strong bottom line results have been driven by unprecedented cost cutting that is unsustainable and has negative implications for the overall economy. The dramatic top line weakness also evident in the 2nd quarter reports shows that the economy continues suffer from a major contraction. Despite appearances, this recession is far from over.
Today’s market action was the most compelling I’ve seen in quite some time. Not only did the major indexes sell off in a big way but the volume was as big as it’s been in quite some time.
321 million shares of the S&P 500 SPDR (SPY) traded hands today – the first time more than 300 million shares of this popular and widely traded ETF have changed hands since April. Volume in the popular Nasdaq-100 ETF (QQQQ) was also strong with 163 million shares trading hands – the most since mid-May. Overall volume of 1.6 billion shares on the NYSE was significantly higher than it has been of late.
I need to see a follow through day of comparable weakness to have real confidence that the correction is upon us. If we do, we’ll find out what the bulls are made of……
Weekly (2) Returns (8/17-8/21 and 8/24-8/28)
Top Gun: -0.76%
YTD Returns (through 8/28)
Top Gun: +5.98%
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