Key Takeaways:

  • Though earnings expectations are diminished across the board, Comms could be one of the bright spots
  • Facebook, Alphabet, and Twitter once again find themselves in the regulatory crosshairs
  • Disney
    announced it would be laying off 28,000 employees 

When you think about the earnings season straight ahead, it’s important to remember that not all sectors necessarily look equal. Among sectors, the Communication Services arena is one that might stand out as investors await a fresh round of company reports.

Third quarter earnings for the overall market are again expected to be extraordinarily gloomy for many S&P 500 companies overall—though once again with lowered expectations heading into earnings season. Research firm FactSet expects an overall average earnings pullback of 21.8%. That’s certainly better than the near-32% drop in the second quarter, but hardly something to cheer about.

Then there’s the sector-specific market. And among sectors, Communication Services scores high marks from analysts, with 59% offering buy ratings on the sector, according to FactSet. That’s exactly where it stood in January and up a percentage point from May.

The bulk of those buy ratings are in the Communications sector components many Americans rely on normally but have gravitated toward with more focus and attention since the pandemic began. We’re talking about Netflix
(NFLX), Facebook (FB), Alphabet (GOOGL), and Twitter (TWTR).

And there’s Disney (DIS). More on that in a bit.

Overall, FactSet expects Communication Services earnings per share to fall a little less than the overall market, about 20.5%. But it actually expects slight year-over-year revenue growth (not decline) of 0.2%. In a normal year, that would probably sound pretty weak, but this year, many companies would probably take it.

No More Fangs in FAANG Stocks?

Speaking of FB and GOOGL, communications sector stocks often get wrapped up with Consumer Discretionary and Technology giants Amazon
(AMZN) and Apple
(AAPL) as part of the FAANG gang, the two—and let’s throw Twitter (TWTR) in for good measure—enjoyed a high-flying ride at the onset of the pandemic until the selloff last month.

Business for these comms giants has been relatively solid as consumers switched almost all their daily tasks—work, shopping, socializing—from face-to-face connections to the world wide web. When e-commerce sales took off, so too did digital marketing and advertising on FB and TWTR’s social-media platforms.

On the flip side, Google Search revenue in Q2 dipped 10% to $21.3 billion—something GOOGL blamed on COVID-related spending pullbacks, particularly with smaller businesses. Analysts said they aren’t convinced that much of that ad revenue has been restored, considering the ongoing layoffs and business closings. According to research firm Trefis, paid search on Google-branded platforms (including Play, Gmail, and Maps as well as the flagship Search platform) account for some 60% of company revenue. So this is certainly a trend to watch.

That aside, last month’s selloff—which was felt by a number of big tech and comms firms—might have had profit-taking as the main impetus for the overall whacking, some analysts noted. After surging double- and triple digits from mid-March to early September, the pressure has been on despite the strong cash troves these companies carry. FB, for example, ended Q2 with $58.2 billion in cash and cash equivalents and no long-term debt other than capital leases.

FB shares shot up a jaw-dropping 100%-plus from mid-March to early September but have lost about 14% of that in the last month. GOOGL shares gained 63% in market value until then too, losing about 15% since. Meanwhile TWTR shares are still trending higher, up 114% since mid-March.

Watching the Regulators

Last week, however, another wrench was thrown in when the Senate Commerce Committee voted to subpoena testimony, yet again, from the CEOs of all three. That looked to be “setting up what could be a contentious hearing with the largest U.S. social-media companies in the midst of a national election,” according to the Wall Street Journal.

FB’s Mark Zuckerberg, GOOGL’s Sundar Pichai, and TWTR’s Jack Dorsey are expected to be grilled later this month about how they’re managing content on their sites, not to mention privacy and other issues, ahead of the presidential election, and crackdowns on hate speech and misinformation as well as fears of interference.

“On the eve of a momentous and highly charged election, it is imperative that this committee of jurisdiction and the American people receive a full accounting from the heads of these companies about their content moderation practices,” said Sen. Roger Wicker, the committee’s chairman.

While that may be just noise, the three—FB and GOOGL in particular—seem to constantly find themselves in the crosshairs of regulators, both in the U.S. and abroad. The most common claims against them have been antitrust and privacy issues.

Investors might want to keep their eyes on the road ahead. Hefty fines, new protocols and the overall maintenance of their sites with such close watch over them could be costly to operations and, consequently, erode profit margins.

NFLX Shrugs Off Competition

Competition has grown for NFLX, but membership—a key metric in the streaming game—has far eclipsed whatever numbers its rivals were able to drum up. As of the end of the Q2, NFLX total subscribers were north of 192 million, some 73 million of which were from the U.S.

But NFLX has warned repeatedly throughout the coronavirus crisis that its swelling subscriber membership growth isn’t sustainable, expecting that much of it has been carried forward by stuck-at-home individuals and families in search of entertainment now. The earnings call could offer more clarity on those numbers.

NFLX’s membership churn—which measures cancellations—spiked in September after a backlash from one of its new releases, Cuties, which some critics saw as exploitative. The backlash had #CancelNextflix trending on Twitter and could have led to more than a few cancellations. An exact number might be unveiled in the earnings report, but many analysts believe the movement was short lived.

Finally, investors might want to listen to insight into that hotly rumored price increase NFLX is said to be considering. “Most likely,” according to Jeffries analyst Alex Giaimo’s take, noting management’s shift in attitude from Q1 to Q2.

“After a change in language regarding pricing on the (Q2) call, we believe a potential hike is probable in the near to midterm,” Giaimo said in a recent note to clients. “In Q1, Netflix said that they were ‘not even thinking about price increases,’ while the Q2 language was more open-ended.”

It could be a huge revenue generator. He estimated a $1 to $2 per month price hike would ring up $500 million to $1 billion in fiscal 2021 revenue. However, he sees a price increase as more likely in Europe, the Middle East, and Africa, which could deliver an incremental $700 million to 2021’s top line.

No Fairy Tale Ending Yet for DIS

DIS earnings are expected again to look like an evil witch prevailed in one of its fairy tales. The entertainment empire that has seen so many corners of its kingdom ravaged with stay-at-home orders and overall fears of being near other people—think Disney theme parks, closed theaters, delayed movie releases, stunted tourism—is looking at a $1.6 billion quarterly loss, according to analyst forecasts.

Granted, that’s a heck of a lot better than the $4.72 billion that was wiped out in the second quarter, yet it’s still a castle full of losses that could continue to pile up. Last month, for example, DIS postponed releases of the superhero movie “Black Widow” and director Steven Spielberg’s “West Side Story” until next year. This week, another chain of movie theaters said it was closing down again as the pandemic lurks.

So many dings to vulnerable revenue streams that the House of the Mouse said it had to cut ties with 28,000 employees, adding to a growing list of S&P 500 companies that are announcing thousands of layoffs.

DIS shares had already been falling before the pandemic forced the quarantines but dove 40% from late February to late March. Since then the stock has recovered much of that ground but shares are still down more than 13%.

Physical and new movies assets aside, DIS+ has been a roaring success in its rookie year, surpassing 60 million premium subscribers while going up against NFLX’s remarkable numbers. What little profit DIS managed to eke out in Q2—$0.08 a share, down 94%—were borne of that success. Some of its streaming channel’s highlights were with the “Hamilton” showing and “The Mandalorian” with the baby Yoda, which won seven Primetime Emmy awards.

DIS is looking to capitalize on that by kicking off “Mando Mondays,” a weekly release of new products tied to the show ahead of the start of the second season Oct. 30. Investors might want to know more about the promotions and what they might mean to a revenue stream that has lost so much of its oomph.

It’s no secret that 2020 has been a challenging year for earnings, and despite a few bright spots, the Communication Services sector has been no exception. But 2021 is just around the corner, and many analysts are looking at an earnings rebound. But just like the movies—where you have to sit through an endless parade of previews before you can enjoy the main feature—it’s important to exercise a little patience. 

TD Ameritrade® commentary for educational purposes only. Member SIPC.