First-quarter earnings season for investment grade issuers is coming to an end the same way it began back in April: Retailers are finishing the trend initially set by banks in posting better-than-expected earnings and revenues. The results highlight the difficulty of proper forecasting given many crosscurrents as the world emerges from the pandemic, with final year-over-year earnings growth exceeding 50% versus initial estimates of up to 20%. The strong results are a positive sign, but we believe more important takeaways will come from what companies are saying and doing as we rebound from the COVID lows of last year.
Key themes from earnings calls included optimism around the post-pandemic recovery in the U.S., but also more mixed global trends, with pockets of weakness persisting in Europe and certain emerging markets. Consumer behavior is in the early stages of moving to a “new normal,” with pent-up demand in certain COVID-sensitive sectors beginning to appear, although little guidance was provided as to the sustainability of recent spending patterns. Inflation comments with a heightened awareness around rising input costs, including for raw materials, logistics and labor, were prominent from companies across a range of sectors. To date, companies appear to be managing through price increases as profit margins remain strong at this stage of the recovery, but management teams acknowledge that they are monitoring whether inflation pressures are transitory or structural in nature.
Corporate actions also indicate that idiosyncratic risks have risen, as companies begin to deploy their COVID-related excess cash. Dividends and buyback programs are being reinstated or increased following the sharp decline last year. Capex spending levels and M&A activity are also on the rise as companies look to take advantage of accommodative capital markets and the stronger economic outlook by growing organically or through acquisitions. Nonetheless, last year’s increase in corporate leverage (ex. financials) should begin to trend lower due to rising cash flows and earnings, with BBB rated industrials remaining focused on strengthening their credit profiles.
Going forward, potential headwinds will need to be monitored as the market begins to look through last year’s easy comparisons. We expect inflation to remain a key focus, along with issues that were noticeably absent from management comments, such as changing corporate tax policy and the evolving regulatory environment. Regardless, the better-than-expected earnings and positive tone tied to the reopening of the economy are currently taking center stage and providing solid support for investment grade credit.