April 22, 2012 / 4:32 PM / in 6 years

Commodities to hold back TSX profit growth

TORONTO (Reuters) - Earnings growth at many of Canada’s biggest companies is expected to have slowed to a crawl in the first quarter due to weakness in commodity prices spurred by nagging worries about the health of the European and Chinese economies.

The first quarter earnings season for the country’s blue chip corporations starts in earnest this week with Canadian National Railway (CNR.TO), Rogers Communications (RCIb.TO), Goldcorp Inc (G.TO), EnCana Corp (ECA.TO) and Potash Corp (POT.TO) reporting results.

Companies whose shares comprise the blue-chip S&P/TSX 60 index .TSE60 are expected to report earnings growth of only 0.7 percent from a year earlier, according to Thomson Reuters StarMine SmartEstimates.

That’s well below StarMine’s 10.6 percent estimate for companies on the U.S. Standard & Poor’s 500 .SPX, a much broader index.

The first wave of S&P 500 results has been substantially stronger than expected, with 81 percent of companies exceeding expectations thus far, according to Thomson Reuters data.

“We think there is a greater likelihood of negative revisions in Canada because of our leverage to commodities,” said Pat McHugh, Canadian equity strategist at Manulife Asset Management.

“The U.S. index has a greater leverage to consumer spending and we are seeing a slow but steady improvement in jobs,” he said. “We are seeing a slow but steady decrease in the unemployment rate. All of that should eventually factor into better housing starts, so the consumer in the U.S. is slowly improving.”

The biggest soft spot on the Canadian index may be the energy space, which has been hit by a drop to 10-year lows in natural gas prices due to moderate weather and record-high supplies. <NGA/> <NGA/CAN>

The materials sector, home to mining and fertilizer shares, has some weak areas that have been hit by signs of slowing demand for commodities in China. The price of copper had fallen to around $8,000 a tonne on Friday from more than $10,000 a tonne early last year.<MET/L}

Earnings for energy and materials companies are expected to have grown by 0.1 percent and 6.6 respectively in the first quarter, with the latter helped by heavyweight gold and silver miners. Bullion prices have benefited from the economic and financial market uncertainty of the past year.

McHugh warned, however, that those estimates may be lofty as the trend has been for earnings growth to fall over the past three quarters, with the last quarter “quite mediocre”.

Analysts also complain that the volatility of commodity prices makes predicting earnings for resource companies very difficult, but that higher production costs are almost certain to have crimped profits.

With the global economy slowing because of the European crisis and previous credit tightening in Asia, it’s no surprise that growth-sensitive sectors such as energy and materials have been the worst performing sectors so far this year.

Kien Lim, associate strategist at RBC Capital Markets, said that the Canadian market’s 50 percent exposure to commodity-related stocks has resulted in a cycle of underperformance versus the U.S. market, a trend that asserted itself last year and “could be a multi-year phenomenon”.

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S&P 500 vs. TSX Composite

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“The structural trend has broken so there could be periods of time in which the TSX outperforms for sure,” Lim said. “(But) I think the longer term trend is down in terms of that ratio of TSX to S&P 500 ... the last uptrend lasted about 10 years.”

Golds are expected to be a bright spot in the first quarter, and investors hope for others in industrials, telecoms, healthcare and banks. Canada’s big banks won’t report their next round of earnings until late May and early June.

On the downside, consumer-staples and discretionary-goods shares, utilities and technology - dominated by struggling BlackBerry maker Research In Motion - are expected to join energy stocks, judging by analysts’ estimates.

Despite a lack of enthusiasm for the first quarter, there are some encouraging signals for the rest of the year. The TSX 60 index is seen picking up as the year goes on, with 2012 earnings growth coming in at 6.4 percent. Earnings growth on the S&P 500 is seen at nearly 10 percent for 2012.

“I feel really comfortable about the earnings for the rest of 2012, even with more punishing news out of Europe,” said Barry Schwartz, portfolio manager at Baskin Financial Services.

Schwartz said he expects earnings beats in non-commodity plays such as banks, retailers, telecoms and other companies that are tied to the North American recovery.

“Each and every day we get more confirmation that the North American economy is growing faster and stronger than some of the analysts are expecting,” he said.

Other observers are even more optimistic about the outlook for Canadian market, even with its weighty commodity exposure.

“America cannot outperform the world in isolation, either the world needs to come in and catch up with America or America needs to significantly catch down with the world,” said Sid Mokhtari, market technician and a director of institutional equity research at CIBC World Markets.

Mokhtari said commodity-related stocks are as oversold now as they were in early 2009, when the market just came off the selloff of the 2008 credit crisis.

“The better bet would be to think somewhat contrarian and actually bet on Canada here.”

Editing by Jeffrey Hodgson; and Peter Galloway

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