Q4 2023’s Mixed Messages: Ongoing Concerns Despite Positive Surprises

Deciding what to make of the financial results and related commentary coming out of the Q4 2023 earnings season? The numbers and dialogue highlight a wide range of sentiment and market expectations toward 2024.  Optimistic outlooks for the year, countered by higher-than-expected inflation data have had a whipsaw effect, with the S&P 500 hitting record highs on February 8 followed by the largest selloff in nearly a year hitting markets earlier this week.

So, what does this mean for the year ahead?

For many companies, 2023 numbers show improvement

In terms of financial results, companies reporting Q4 2023 and full year earnings are beating expectations, with more than two-thirds of the S&P 500 reporting either a revenue or earnings surprise versus consensus. Per Factset, companies in the index have reported 2.9% earnings growth on average, marking the second straight quarter of growth. The health care, information technology, energy, and consumer discretionary sectors are largely responsible for these positive earnings surprises.

Management is keeping a sharp eye on costs and demand, putting the most focus in three areas

Amidst some encouraging results, management teams continue to pay close attention to their costs and how they are affecting margin and demand. The most common recurring themes this earnings season provide further context about the performance of the market and shed some light on where the biggest concerns lie. Here’s where management teams are concentrating:

1. Operational efficiencies

Companies with pressured margins and earnings are intensifying ongoing efforts to enhance operational efficiency and optimize processes. Strategies include investing in automation, digitization, and process improvements to streamline operations, reduce costs, and maximize profitability.

However, how the efficiencies are actually created vary widely between management teams.

On its recent earnings call, industrial technology company Fortive highlighted the effectiveness of the Fortive Business System (FBS) for driving performance improvement across various business segments and helping to deliver 2023 results above prior expectations¹. Fortive emphasized the competitive advantage that FBS delivers by continuously improving operational methodologies and tools to enhance productivity, reduce waste, create new market opportunity, and accelerate new growth. Waste Management cited its management of “the middle of the P&L” as a standout piece of its robust EBITDA expansion in the fourth quarter, centering on “proactive measures to accelerate and improve cost efficiency,” including “leveraging technology to manage labor, managing repair and maintenance costs, and optimizing our overall cost structure.” On the other hand, Tyson Foods reported plant closures across its footprint as a major driver of its recent earnings beat despite heightened beef prices and uncertain consumer demand².

2. Resilience of consumer demand in certain sectors

Despite inflationary concerns and rising household debt, consumer sentiment has risen to highest levels since July 2021^3,4, reflecting brighter consumer outlook toward personal income and inflation. General Motors is just one of many companies benefitting from this sentiment, noting the health of brand sales growing year-over year and increasing US market share margin expansion⁵.

Ralph Lauren also beat quarterly earnings expectations. The company’s leadership notes strength even as it recognizes its price-sensitive shoppers.  A recent Reuter’s article⁶ quotes the fashion company’s CFO/COO Jane Nielsen as saying, “They’re still shopping. They’re looking for quality brands they trust, but wanting to get a deal,” and acknowledges the importance of promotional offers and outlet stores in driving sales.

It’s a different story for other sectors, however, and for some companies, results are taking a hit. McDonald’s is seeing fewer visits from lower-income customers as prices increased 10% over the past year, prompting CEO Chris Kempczinski to note the “battleground” with the company’s key demographic⁷. Both Coca Cola and PepsiCo are beginning to see top line impact due to waning pricing power: Coca Cola’s revenue grew 7% in the fourth quarter, down from double-digit growth in the prior year period, while PepsiCo’s revenue declined 0.5% over the same period, both attributed to shoppers focusing more on affordability and spending more time at home. That said, PepsiCo noted optimistic toward consumer health however, expecting wages to outpace inflation this year with future rate hikes likely to serve as a tailwind for consumer spending⁸.

3. Heightened, yet stabilizing labor expense

At the macro level, US labor costs are historically high, but signs do point to some relief. The BLS’ Employment Cost Index rose just 0.9% in Q4 2023, the smallest increase in this indicator since 2021. Online payroll and HR solutions provider ADP has also noted a slowdown in the growth of worker pay.

This doesn’t mean that companies aren’t continuing to feel the impact of increased labor and wage expenses on results. Indeed, many businesses continue to note this widely along with their various methods of addressing the costs. Inevitably, some will cut staff. A Washington Post article⁹ shared UPS’s announcement to reduce the workforce 2.4% in the wake of Q4 revenue declines. The shipper points to higher labor costs as the result of a new agreement with the Teamsters union.

Ford is also facing increased labor costs coming out of a recently negotiated UAW agreement anticipated to nearly $9 billion over the next four years. The company anticipates lower profitability as result. The company did beat Q4 2023 consensus estimates, however, and is targeting $2 billion in cost reduction initiatives to offset higher labor expense and achieve FY 2024 guidance, which includes a 6% increase in adjusted EBIT versus 2023 results⁹.

This far into fourth quarter 2023 earnings, the focus remains on painting a picture of resilience and balancing optimism with the realities of lingering headwinds. As businesses grapple with ongoing challenges, investors will continue to take a stock picking approach, looking for undervalued companies and relative outperformers in a volatile environment.

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Sources:Fortive Reports Strong Fourth Quarter and Full Year 2023 Results,Tyson reports earnings beat, but high beef prices stress its consumersS. Consumer Spending Resilient While Debt RisesS. Consumer Confidence Jumps Again — University of MichiganGM Releases 2023 Fourth-Quarter and Full-Year Results, and 2024 GuidanceRalph Lauren rides strong holiday demand, China rebound to post upbeat resultsMcDonald’s Sales Fall Short as Middle East Boycotts Hit HomePepsiCo Earnings Had Some Bad News: People Are Snacking at Home LessUPS layoffs: 12,000 jobs to be cutFord Beats Earnings Expectations Despite Rising Labor Cost