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August 31, 2021 | GSAM Connect

Credit Check-In: Themes From Q2 Earnings Season

Second quarter earnings reports reveal that many measures of corporate health have normalized to pre-pandemic levels. We discuss three key takeaways from Q2 earnings and what we’ll be focusing on for the remainder of the year.

From recovery to normalization

After an impressive Q1, the majority of companies showed further strength in Q2, beating expectations for revenues, operating leverage and earnings. With over 90% of companies in the S&P 500 having reported, a record-breaking 87% of companies beat consensus earnings expectations; corporate profits in aggregate have now risen above the previous record peak level and above the expected normalized level had the pandemic not impacted 2020 numbers. That being said, there is still a wide range of profitability between industries.

Balance sheets also continue to improve on a number of metrics: gross debt balances have moderated over the first half of the year, net leverage is still moderating and asset coverage (measured as the ratio of debt to enterprise value) has improved for most of the market.

Climate transition capex plans

Robust revenue and earnings growth have supported operating cash flows. While most of the market is still retaining ample cash flow, we see several trends in capital allocation.

An underlying trend of decarbonization is having widely varied impacts on capital reinvestment across several related industries. Utilities had the largest increase in capital expenditure (capex) and continue to outspend cash flow as they fund the decarbonization of their generation fleets and support growth in renewables. Yet energy companies, particularly in exploration and production, have remained highly disciplined and actually decreased capex, even with higher oil prices. In the middle are auto companies, which have been spending to meet electric vehicle demand but in the context of stable capex.

We also note an increase in returns to shareholders – in part due to easy comparisons from a year ago – but also as part of a normalization trend with improved cash flow. We expect to see more merger and acquisition activity and announcements for dividend increases and share buybacks.

Challenges of inflation and transportation

Rising raw material costs and shortages of products – from microchips to chicken – are the latest signs of inflation and supply chain disruptions that are presenting challenges for many companies, particularly across the high yield universe. While companies offered varying opinions as to whether inflationary pressure would be transitory or more permanent, transportation bottlenecks will continue to disrupt supply chains for some time; the industry is grappling with labor shortages of dock workers and truckers – at a time when the US trucking industry is already running at 100% capacity – and severely reduced international air freight traffic.

Despite the challenges of inflation and supply disruption, strong demand across a diverse range of industries, from chemicals to homebuilders, has helped to offset the impact on corporate margins. In fact, most industries managed to actually improve margins year over year through a combination of operating leverage, cost cuts and selective price increases. However, this is an area we will continue to watch closely as inflation pressures and supply chain issues persist.


Overheard at Goldman Sachs

“Despite some inflationary pressures, most industries managed to improve margins year over year.”

— Steve Waxman, Head of the Global Investment Grade Research Team

Goldman Sachs Asset Management Forum | August 2021

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