BAY STREET-Weak commodities set to punish company profits

Sun Oct 14, 2012 10:29am EDT

* As on Wall Street, poor Q3 earnings seen for Canada
    * TSX 60 company profits are forecast to fall 0.4 pct y/y
    * Biggest weakness expected in energy, mining stocks
    * Financials seen outperforming

    By Claire Sibonney
    TORONTO, Oct 14 (Reuters) - Canada's biggest companies may
join their Wall Street peers in posting poor financial results
for the latest quarter as miners and energy producers struggle
with soft global demand and volatile commodity prices.
    Energy and materials shares make up about half of the value
of the Toronto Stock Exchange's benchmark S&P/TSX composite
index and include such blue chips as Cenovus Energy
, Teck Resources Ltd and Goldcorp Inc.
All three are expected to report a year-on-year drop in
third-quarter earnings per share in the coming weeks.
    Overall, companies in the blue-chip S&P/TSX 60 index
 are expected to report an earnings decline of 0.4
percent from a year earlier, according to Thomson Reuters
StarMine SmartEstimates.
    And if warnings from U.S. resource giants Alcoa and
Chevron last week are any indication, there's also a
high risk that Canadian companies could issue disappointing
outlooks that could hit their stock prices.
    "We have had strong earnings for the last two to three years
for S&P and TSX," said Craig Fehr, Canadian market strategist at
Edward Jones in St. Louis. "Those trends have powered equities
higher during that time but we're now running up against the
situation where the economic environment on a global scale has
softened. 
    "Corporations are struggling a little bit more now to
deliver that profit growth because much of the cost savings that
they were extracting over the past couple years have been
realized."
    
    TSX LAGGING S&P 500
    With the global economy sputtering because of Europe's debt
crisis and a slowdown in Asia, it's no surprise that
growth-sensitive sectors such as energy and materials have been
among the worst-performing sectors this year.
    This has caused a dramatic gap between Toronto's S&P/TSX
composite and the much more diversified S&P 500 index. The TSX
is up 2 percent in 2012, while the S&P has gained 14 percent.
 
     Fehr noted that while commodity prices have been volatile
day to day, the broader trend has been one of weakness. This is
especially true in the energy space, which is expected to show
an earnings decline of 15 percent, according to Thomson Reuters
data.
    Because of limited ability to move Canadian crude oil
abroad, local producers are saddled with a discount to
international prices, especially for heavier grades. And natural
gas prices remained weak throughout the third quarter.
    Even when oil prices spike, it doesn't necessarily translate
into higher profits.
    "It's more supply concerns versus actual demand for oil - so
for example unrest in the Middle East - that's what's pushing
oil prices up," said Kien Lim, associate equity strategist at
RBC Capital Markets. "It's probably less impactful for the
bottom line." 
    
    MATERIALS DRAG, FINANCIALS RESILIENT
    The TSX index's materials sector, home to miners of
industrial and precious metals and potash, looks in much worse
shape than the overall index, with profits expected to fall 19
percent.
    Commodity prices are not entirely to blame. The price of
spot gold, which traded around $1,762.20 an ounce on
Friday, is up from a year earlier. Yet shares of Canadian
precious metal miners have fallen 7 percent this year.
    "Gold stocks have not performed anywhere near to the same
extent as bullion because the costs of getting it out of the
ground have gone up a lot higher than gold has," said Gavin
Graham, president of Graham Investment Strategy.
    Much of the good news for the TSX this quarter is likely to
come from financial companies, which make up about a third of
the composite index. 
    Canada's stable dividend-paying banks, which don't start
reporting results until November, have performed relatively well
since the 2008-09 global recession.
    By comparison, insurers such as Manulife Financial Corp
 and Sun Life Financial Inc have taken a
beating as historically low bond yields and languishing stock
markets have hammered their profits.
    But when compared with their dismal results last year, the
insurers are set to show impressive earnings growth. As a
result, earnings in the financial sector are expected to rise
nearly 70 percent.
    "The denominator is relatively small, so that's why the
comparisons look so great," said Pat McHugh, Canadian equity
strategist at Manulife Asset Management.
    
    VOLATILITY SWINGS BOTH WAYS
    Even with mediocre earnings expectations - 1.4 percent
growth for the TSX in 2012 overall - Canada's market is still
expected to grind higher in the final quarter.
    A Reuters poll published last month forecast a rise by the
TSX to 12,800 by the end of the year - it was at 12,202.04 on
Friday - buoyed by a central bank stimulus-inspired rally. That
rally has pushed global equities up around 15 percent since
early June, but it has stalled recently. 
    "We've got the upcoming U.S. election, the U.S. fiscal
cliff, the situation in Europe that continues to drag on and a
slow-going Canadian economy," Fehr said. "All that boils
together to, in our view, create probably a lift in volatility
as we progress through the balance of the year. 
    "But volatility doesn't have to mean just market declines,
volatility is a door that swings both ways."
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