Another earnings season is underway in the U.S. with Alcoa reporting numbers that beat both sales and earnings expectations last week. Is this a harbinger for what investors should expect from the Canadian Materials sector in the Q1 earnings season and for the 2012 calendar year? The key lies with profit margins.
So far this cycle, profit margins for the Materials sector have surged to unprecedented levels. The big question is whether margins can continue to contribute to EPS growth. Commodity price dynamics and global growth expectations point to a period of possible disappointment on this front. However, the recent price consolidation among Material sector stocks suggests that markets have in part priced in a stabilization of profit margins.
EPS growth estimates have come down significantly over the last 6-months with 12-month forward earnings revised down by a whooping 15% over the period. This explains why the sector has been out of favour with investors so far this year. That said EPS expectations for calendar 2012 and 2013 still calls for solid growth. This explains why valuations have become so attractive following the recent market retrenchment. Bottom line, the Material sector’s performance in 2012 will depend in large part on profit margin dynamics.