FactSet Research Systems Inc. (FDS) Earnings Call Transcript & Summary

It's a few minutes after high noon here on the East Coast. Welcome to Market Call 2022 Outlook brought to you by FactSet. I'm Guy Adami. I'm joined by Dan Nathan. Dan, how are you?

I'm doing great, Guy Adami. It's great to be here, sponsored by FactSet.

I'm all hyped up as you can tell. Listen, over the next 30 minutes, we're breaking down 3 market-driving themes for the year ahead. Energy, Earnings and ESG to help you make smart investments, hopefully, really smart investment decisions going forward. But Dan and I can't do this by ourselves. So today, we're joined by 3 all-stars, absolutely. Kathryn Miller, President of BTU Analytics, a FactSet company. She specializes in energy industry, market dynamics. John Butters. You hear me wax poetic each week about Butters, Vice President and Senior Analyst at FactSet. You also know him from his weekly research report, Earnings Insight. And Eliot Caroom, Senior Product Manager at Truvalue Labs, another FactSet company. He focuses on new applications for ESG. Folks, welcome. I'm going to get right into it.

Kathryn, energy is clearly a story. The volatility in crude oil has been fascinating, not only over the last year but the last 1.5 months, 2 months. So let's talk about oil volatility and your projections for next year.

Yes, Guy. In oil markets, if you've liked the last 2 weeks, you can expect a lot more of that in 2022. We're really in for a wild ride. Fundamentally, demand is expected back at pre-pandemic levels next year, but government reactions to new variants, any news or actions on Iran, any discontent about the -- within the OPEC coalition, we expect all of this, too. There's going to be plenty of [ moments ]. We're modeling that the OPEC agreement to continue with its planned increase in the group's January production quota. We'll keep prices kind of packed at $80 for the next few months before global oil balance moves back into a slight surplus next year and push prices, maybe a few dollars lower. But we should really take a step back and talk about what these oil prices mean to the overall sector and the outlook. And I did bring a chart here that shows WTI prices versus the cost to produce. The outlook for near- and medium-term profits in the sector is really as constructive as we've seen in the last decade. And that's because the median cost to produce oil in U.S. shale plays is $35 to $40. Any price north of $60, that's great for the sector. But what's really great for the sector is the stakeholder pressure that's been on traditional oil and gas companies to show consistent returns and not reinvest this extra cash that they're taking in new production. That really sets up a more sustainable outlook than we've seen really since the era of shale began.

It's been fascinating to watch, though, some of the decisions being made on the back of higher prices. Energy has now become this political battleground, and I'm not asking you to play politics here, but just in terms of what you saw with the release of the SPR, maybe it helped in the short term. But in your opinion, did we fired -- we, the United States, do you think we fired that bullet a little too soon?

Oh, I think definitely. If we're starting to play politics, not on necessarily physical means of crude, but really trying to defend price, we're really opening a Pandora's box here. And there can be real emergencies within the oil sector that require SPR coordination. But I think at this point, [ too ] young for the market and now we fired our shot.

One more question before Dan has a question for Mr. Butters. I'm just going to ask you, again, fascinating volatility, the price points I see for 2022 are all over the board. I've seen anywhere as low in the mid to -- mid-40s to people talking about north of $100, you could drive a truck through that range. I think it seems like a lot of people are coming down. We're going to stay in this range of sort of $60 to $85. I mean could we go outside of those parameters? What's the tail risk do you think in terms of the price for the commodity?

Yes. Listen, if we have discontent within OPEC, if somebody decides they don't want to play ball, then we can break through those parameters. We can go through $60, go lower. It's not out of the question and the tails are fat in this case. Structurally, we are moving towards that environment, and this is one of the reasons we're so constructive on crude oil. Structurally, we're moving towards an environment, where we're managing reinvestment within the oil sector within the U.S. And that's really been the tipping point that has pushed oil balances to surplus in the past. So we're setting up structurally to have higher prices longer term. I mean we could see $80, $90, $100 a couple of years out. And we could have some shocks that push us there sooner. But I think we really do have a fundamental shift in the structure of the crude oil markets, and it's bullish longer term.

Yes. Surplus is not something we've heard a whole heck of a lot in this supply constrained world that we live in, given all the bottlenecks that we know that have been a result of the pandemic. I got to shift towards John Butters here. John, I've been reading your Earnings Insight blog for years and years. We get the opportunity to preview it every Thursday on Market Call before it drops on Fridays here, and we've been tracking -- I mean I find as an investor and as a trader, I find where we see earnings revisions and what sectors and what the expectations are, the upward revisions and who has the highest growth rates, really fascinating. It helps really explain a lot of the capital flows and the rotations that we see in market, and that's been a huge theme in 2021. Here's the thing, based on everything that Kathryn just said on the energy sector, and we spend a lot of time talking about energy because it's an important input to a lot of other, obviously, companies and margins and that sort of thing, what does it mean to you that energy is less than 5% of the weighting of the S&P 500, despite what you've been tracking are high growth rates and high upward revisions in the space?

Right. Well, energy is certainly expected to be one of the drivers of growth as we go into 2022. So looking at the big picture, overall, despite a difficult comparison to record high earnings expected in 2021, analysts are still calling for pretty solid growth overall in earnings for 2022. So in terms of earnings, we're looking for about 9% growth year-over-year, and on the revenue side, we're looking at about 7% year-over-year growth. And so it should be noted that both of those growth rates are above recent averages. And also, both of those growth rates are based on a compilation of the individual 2022 EPS estimates and revenue estimates for all the companies in the index. But in terms of revisions, it is interesting to note that analysts have actually been raising their estimates for companies for 2022 throughout the year. And if we really narrow in on revisions since September 30, one sector really stands out in terms of upward revisions, and that's the energy sector. So since the start of the fourth quarter, we've seen a 20% increase in expected earnings for 2022 for the energy sector. Now it is important to note that movements in estimates for the energy sector are highly correlated to movement in oil prices. So given the recent pullback we've seen in oil prices over the last couple of weeks, we're certainly going to watch for any downward revisions to estimates to the energy sector, which again would affect the overall earnings outlook for the S&P 500. We haven't seen them yet, but certainly something we want to keep a watch for over the next few weeks.

Yes. And so last week in your Earnings Insight, John, you had a mention that generally, strategists seem to overestimate the forward years earnings estimates by I think you said an average of like 7.5% or so. When you're looking at a sector like this, that is a small percentage of the S&P 500, but those large expectations and growth rates built in, what does it mean if that actually comes to play and we do -- because we have higher energy places, what might it mean for the rest of the corporate earnings and other areas of the market, other sectors that that might be a headwind to margins?

Right. So in terms of margins, analysts are really optimistic in their outlook for 2022. So right now, the expectation is for a net profit margin of 12.7%, and that's actually above the expected profit margin of 2021 at 12.6%. And if we hit 12.7%, that would be the highest profit margin reported by the index on an annual basis going back to at least 2008. But to get to your point about overexpectations of analysts, we certainly know that over the last 25 years, analysts have overestimated earnings at this point in time for the following year. However, we're also in an interesting place where, over the short term, analysts have underestimated the earnings recovery from COVID-19. So if you go back to last year, about second quarter of 2020, we had the height of the lockdowns. And since then, analysts have been behind the ball, behind the curve in terms of raising their estimates. So a really interesting point in time where we know over the long term, analysts tend to overestimate, but over the short term, they've underestimated. So I think because of that, you really want to watch the guidance that comes out for 2022 when companies start reporting their fourth quarter results in a few weeks. So we know, like I said over the past few quarters, guidance has been more positive than normal. In the fourth quarter, we started to see a little bit of a shift towards the negative. So again, we definitely want to watch the 2022 guidance as it comes out over the next couple of weeks.

Eliot, before I go to Kathryn on natural gas, obviously, ESG and the energy space, collision course in a lot of different ways. Methane obviously has become a buzzword. Can you speak to the word methane and all the implication it has in your world, the ESG world?

Sure. Absolutely. So methane, which is the chief component in natural gas, was a huge focus at COP26 in Glasgow, with more than 100 countries signing a global pledge to control the greenhouse gas, but it's really a high-level target setting. How that trickles down to different industries and different companies in terms of stakeholder attention on the ESG front and regulator attention is going to have big reputational consequences and consequences with a cost of doing business. As you can see in this chart right here, mentions of methane on earnings calls over the last 10 years, pretty steady, and then they've gone way up this quarter and the prior quarter. So about 43% of that, you can see in the smaller pie chart is due to energy companies. So oil and gas, mainly upstream and midstream, but that's not even totally the end of it, has a big share of that. Where this might grow and affect other industries is there are other industries who are big contributors of methane, which is this man-made, many times released by humans, very powerful greenhouse gas, and these can include waste management, dairy, agriculture. They're going to get a lot more scrutiny because satellites are launching from the Environmental Defense Funds and other groups, including a coalition with NASA and state regulators in California. So attention is coming for methane.

It's fascinating. [Operator Instructions] Kathryn, real quick, natural gas, I mean, back in the days that I traded commodities, that was one of the things that we used to dabble in. We had a lot of different names for it, none of which I will mention here. But the volatility in the nat gas space has been unprecedented as well. And a lot of concerns out there in terms of what's going on in Western Europe, the ramifications with Russia controlling so much of nat gas. There are so many moving parts. Can you sort of speak to what's going on in nat gas here now and going forward in 2022?

Sure. I mean if you took an extended Thanksgiving break, you missed the biggest 1-week decline in natural gas prices since 2014. I mean 60-degree temperatures in New York City in the month of December is going to change your outlook for winter gas demand. And yet, we've got this contrast with what's happening in Europe, where it's been very cold, prices continue to surge, inventory is still not where it needs to be there. So Henry Hub winter pricing has gotten crushed, down $0.85 since the end of November. Summer strip pricing has not been hit as hard. It remains under $4 -- just under $4 per MMBtu. But when we look at what -- where we're at today, we continue to see within our outlook that there's going to be this disconnection between markets, because we can only export so much natural gas via LNG. So that European market can disconnect from us. And in fact, if we continue to see trends in warm weather here in the U.S., the path that we've been on, we could see natural gas fall all the way down to $2 this summer. So we last published our outlook for natural gas at the end of November. And at that point in time, we were bearish that the strip and obviously, it's moved a lot since then, even with where the strip is today, with the trend we're on, we're still bearish.

John Butters, let's talk about earnings call mentions because we've gone over a lot of stuff here. And ESG is one, high input costs is another. Are we starting to see -- or did we start to see at the tail end of Q3 earnings some higher mentions about some of these things that might be impacting near-term earnings?

Right. We've tracked a number of hot topics on earnings calls for Q3 over the last few months, supply chain being one of them, where 70% of companies in the S&P 500 talked about supply chain. Inflation being another, where 60% of S&P 500 companies talked about that on their earnings call. But another topic that's really cropped up in recent quarters is ESG. So for the third quarter, we had 134 companies talk about ESG. That was the third highest number in the past 10 years. And that's really a trend we've seen over the last couple of quarters much higher mentions of ESG. So for example, over the last year, the last 4 quarters, we've averaged 140 companies talking about ESG. If you look at the previous 3 years from late 2017 to late 2020, that number averaged less than 30. So we've seen a significant pickup over the last year in companies talking about ESG.

It's interesting, John, I mean ESG is just one more component to the very difficult picture you need to sort of put together in terms of earnings and your outlook and stuff. I mean just quickly, in terms of your outlook for 2022, a lot of moving parts, a lot of pull forward, a lot of people think earnings in the first quarter of next year are going to be disappointing. Just sort of curious as to what your thoughts are as we get into what's very quickly going to be the first quarter of 2022?

While we're in terms of the first quarter looking for about 5% earnings growth, that dips down to about 3% in the second quarter, but there is an expectation that we'll see an improvement as we get into the back half of 2022. So it is interesting on profit margins as well. Again, a dip expected in Q4 and Q1, but then an expectation that will pick up again in the second half of the year. And again, as we talked about, culminating in a peak profit margin of 12.7% for the year. So again, a little bit of a dip expected in the first half, but then more of a recovery expected in the second half of 2022.

[Operator Instructions] We're getting some questions now that we're parsing through. Eliot, biggest themes, 2022 ESG, I mean there's going to be a lot to talk about, no doubt, and you're going to be extraordinarily -- I'm sure you're very busy this year. My sense is you'll be even busier next year. Talk to me about the themes for ESG in 2022.

The importance of ESG is growing because it's going from the ground up. Investors care about it, from small individual investors to institutional investors, and that's only increasing. And when we look at ESG, it's often just this acronym, but it's really not an amorphous single thing. And the true value adds, we track 26 different ESG categories. And I think I have a chart on this of the prevalence of each category within our overall data set since January of 2020. And so when you look at what's really been the most important categories, first of all, it kind of looks like spaghetti towards the bottom, right? A lot of them are really close together out of the 26 ESG categories, and these are in areas like social and labor and things like that. Now at the beginning of the pandemic, we saw spikes in employee health and safety. That's a blue line early in the chart and also in labor practices. Those were key because people were really focused on how to protect employees and when they weren't being protected, how they were suffering. But the 2 green lines that are steadily gaining over the last nearly 24 months, these are climate-focused categories, greenhouse gas emissions and product design and life cycle management, which deals with how products are responsible for carbon emissions over the lifetime of a consumer product. And so this focus is just consistent and growing steadily on these key climate areas. They both are now above 10% each. So taken together, they're about 1/4 of all ESG volume that we're seeing in our data set. This is covering our whole universe of around 30,000 companies and tons and tons of sources we aggregate on a daily basis. So this is truly big data and climate is the word for sure.

So Kathryn, I want to go back to some things that we talked about at the start of the program here, and we were talking about obviously the U.S. and some other nations tapping this SPR and the timing was probably luckier than it was by design, and we saw that big move lower in crude oil. We've seen a lot of volatility. And I think you said this. I mean relative to, let's say, the S&P 500 or a lot of related sort of equity centric that crude's been really volatile. It's had two 20% peak-to-trough drawdowns in just the last 6 months or so. But the question I have for you, all of that is without anything geopolitical. What if there was a dust up with Iran in the Middle East? What if there is some sort of action on the Russian-Ukrainian border? We know that that's really important as it relates to natural gas for Europe. Are those things that you're thinking about are going to be more prevalent in 2022?

Well, listen, I'm not going to sit here and try to predict those events. But we do know that they happen with a little too much regularity, but we would expect that there are going to be things that happen that require potential action in the market -- reaction in the market. We see that the market has done what it's supposed to do, whether it was in reaction to the start of COVID, we saw [ challenges ] [indiscernible] [ U.S. ] and remember that there's still plenty of spare capacity out there. Just because OPEC doesn't want to use it today, it doesn't mean that they won't use it in the future if it's necessary. So I do think that there is an overall desire to have some stability in prices at levels that we're basically at today. So yes, it's going to be volatile. It's going to move around. We are going to get surprises. But there are a lot of parties who would like oil prices to be fundamentally between $60 and $80.

Yes. No question about it. And I'm one of these people, not that it matters what I think, but I do think energy has been a story this year. I think it's going to be a huge story in 2022, maybe for some of the right reasons, probably for a lot of the wrong reasons, but what do you see, Kathryn, the opportunities in the space in 2022?

Yes. I think one of the key catalysts that we're watching in the market is that in the U.S., public independents are continuing to practice capital discipline, which has really been a key differentiator in keeping global markets balanced, keeping OPEC with a plan as far as what they're doing with spare capacity. So what we're seeing is instead of reinvesting capital in the field, these E&P companies are instead favoring flatter production and using cash flow instead to pay down debt. So we see cash flow reinvestment rates from operations have been about 50% to 70%. That really gave about 30% of cash flow available to E&Ps to pay down debt that maybe they brought on during the COVID crisis. But what we're seeing is that over the next year, a lot of these companies are nearing their debt -- their long-term debt targets. Not even short-term targets. These are the long-term debt targets that they'd like to get to. And once they get there, these companies are going to have a choice. What are they going to do with the rest of that capital? And we expect that capital to go to investors, whether through share repurchases or through variable dividends. So we really see that as a catalyst for the sector. And if prices find some relative stability, we would expect to see that around midyear 2022.

Yes. So it's interesting that you mentioned you kind of put it together, you book ended it with the COVID dislocations and then obviously, there's some geopolitical stuff. And then one of the things that I think is kind of fascinating, we have a couple of quick charts here, we'll just pull up here is that I go back to 2013 to '14 when crude oil was above $100, right, we still were -- we did not start to taper. The Fed had not started to taper yet, and we hadn't come off [ ZERP ] yet. But as soon as we started to, rates started going much higher, the dollar started going much higher, and that was it for oil. I mean that was it. I mean, right? Like crude oil went down '14 and '15 and it made a bottom in '16, I think that 65%. So I think that's something really worth keeping an eye on because, listen, I'm just a dumb stock trader, okay? But I have to go back on certain patterns. John, what was the -- what would your impact be if a higher dollar, okay, on earnings, right, we're talking about possibly lower margins. But if crude were to go down, I mean, are these all things that are kind of factoring in rates, dollar and energy prices, because obviously, inflation has been the main story of late?

Right. Well, as we said, again, the expectations for profit margins are to improve. So it looks like that the expectation is that companies are going to be able to raise their prices to help mitigate some of these cost increases. Certainly, on the interest rate front, when we look at 2022, we do see the one sector expected to see a decline in earnings is the financial sector. Earnings actually rebound about 9% year-over-year. Again, interest rates aren't helping as banks tend to do better in a higher interest rate environment. So we look at the overall picture, it is interesting that while we're expecting broad-based growth, 10 of the 11 sectors are expected to see growth again. Financial is the only one for decline. The 3 sectors that are expected to drive growth are consumer discretionary, industrials and energy. Now within 2 of those sectors, there's -- consumer discretionary and industrials, there's an expectation of an improvement in travel and leisure. So for example, in consumer discretionary, the industry that's really driving that growth is hotels, restaurants and leisure. On the industrial side, the airlines industry is expected to drive growth. So again, as we look at concerns about the new COVID variant, if there's anything that's going to impact travel and tourism in 2022, that could have a bigger impact on earnings because those are really some of the industries where analysts are expecting the biggest improvement going into 2022.

Eliot, we have a question from one of our audience members. I don't think he or she is looking for you to get granular in terms of stocks. But the question is, are there any sectors that could benefit, in your opinion, going forward with this? Again, ESG is going to become more and more important, not only the last couple of months of this year, but next year as well. So do you see any sectors benefiting from sort of this advent of ESG investing?

Sure. I mean, ESG, it's not a monolith. There's different investing styles, different strategies. I think one key thing to look for is engagement, impact investing. And one of the most conspicuous examples of this in the ESG space is maybe Engine No. 1, who seated 3 members on the ExxonMobil Board. This was a pretty groundbreaking event. It's wildly successful as ESG impact investment moves go and they did it with the coalition of Vanguard, BlackRock, State Street and others. And as ESG impact investors make moves like that, and Engine No. 1 says it explicitly, they think that the firms that produce the most negative externalities actually perform the worst. And it's part of their total value framework that they've recently published on with Wharton Professor Wit Henisz. And so ESG investors engaging with companies, the idea is they can improve the company ESG performance by reducing the externalities, which is a fancy way of saying ways that they hurt consumers, hurt everyday people cause -- contribute to climate crisis. So if you engage on that and get out ahead of regulation, then maybe you have a best-in-class waste management firm, all of a sudden, who, when the satellites go up, is not producing super emitter methane sites from a landfill that could easily be controlled. Maybe you are able to manage more landfills because of that. And I think overall best-in-class performance is poised to be rewarded because we're still really early in the ESG story here. It's been a couple of decades, but it's still evolving rapidly. With the amount of interest coming into it, I think that's an area to watch. Engagement, improving company performance, reducing externalities, those kinds of things are going to be rewarded.

That's great -- I'm sorry, Dan, go ahead.

Yes. So I was going to say we have a question from William. It's directed to me, but I'm just going to put it out there. I'm going to ask you, Guy, and then maybe if our panel if they want to opine that. What are some of the top energy stocks to trade going into year-end and potential returns, given a slower SMB target for 2021? Some of these SMB targets are starting to come out. I think this morning, JPMorgan had a 50-50 year-end target. And you guys know where we are, we're just below, what, 4,600 or so. Guy, are there any areas within tech -- or excuse me, within the energy sector, maybe without getting too granular again, that you think are really interesting? Obviously, large integrateds have tracked the price of crude. And then oil services names have been a lot more volatile though.

Yes. Again, I'm not going to play stock market necessarily, but what I will say, and I'm sure the folks can do their homework. I think you want to be in the levered energy names, levered to the price because I'm of the belief that the price of crude oil and energy in the aggregate is going to go higher, not only early in 2022, but throughout the year. So I'm a believer of higher energy prices, you want to be in the levered names. Kathryn, I'll throw it to you, again, not playing stock markets, but does that make sense to you?

Yes. That totally makes sense. I think when we're looking out, we're not often constructive on oil and gas prices. But this is a moment where we can see the upside having a real shot. And so I think looking there, but also looking at energy names that have spent time investing in ESG practices, have spent time thinking about how to make sure that they maintain a license to operate into the future. Those are names that are really, I think, we're going to see differentiated performance in some of those energy names as well. The folks were really thinking about how do we make sure we've got the market and we've contracted with the right parties to have the ability to produce now and into future.

Yes. All right. I got one last one. This is for John Butters here. And I just love the fact that we get you. We don't -- Market Call every Thursday, we get to read your preview and we get to talk about it, but here I have the opportunity to ask you a question. Over the last couple of weeks, we've seen some high-profile earnings, I guess, guidance downgrades by -- Salesforce was one of them. We're not going to pick on Salesforce, but the next day, the stock was down 11%. It's a big market cap company. I've been in the markets now for 25 years. When you see high-growth companies, right, start to kind of miss on some of their earnings estimates going forward, usually that's a bit of a tell. Are you starting to track this a little bit because really, we've been talking about earnings revisions to the upside, right, for a while might that change the tune a little bit as far as equity valuations are concerned. If we were to start to see some Q1 downgrades to earnings estimates. And really, if we're able to put our finger on the fact, maybe it is a margin issue and maybe expectations for margins are a little too high and why we have more muted equity returns going forward because of that.

Right. So if we take a step back and look historically, typically, analysts usually always take down their estimates during the course of the quarter and more companies issue negative guidance or guidance below analyst expectations and positive guidance. However, that trend got completely flipped once we went through the period of COVID. So in the second quarter of 2020, we saw analysts take the estimates down tremendously, some of the largest cuts to estimates we've seen historically. And a lot of companies either gave negative guidance or withdrew guidance completely. Since that time, the trend has been more companies issuing positive guidance than negative, analysts revising estimates upward than downward, and more companies beating those revised upward estimates and beating by wider margins than normal. But it looks like in the fourth quarter, we might be at an inflection point. Again, we got about another month or a few more weeks to go in the quarter. But to your point, we've -- this quarter is the first time since the second quarter of 2020, we've seen more companies issue negative guidance than positive guidance. And the estimate revisions had started higher during the first month of the quarter, they've now shifted negative. So overall, we're flat. The expectations are basically today where they were at the start of the quarter, but this could be an inflection point in terms of getting back to the historical patterns of more negative guides, more downward revisions. Again, we'll have to see how the rest of the quarter plays out.

I want to be respectful of everybody's time. We tried to keep it around 30 minutes. I think we're right around there. I obviously want to thank our panelists, Kathryn Miller, thank you. Eliot Caroom, John Butters, thank you for joining us. Obviously, I want to thank FactSet as well. There will be a replay of this posted on our YouTube page. Dan Nathan, I want to thank you. I want to thank all the folks at OpenExchange because they manage virtual meetings that matter. Obviously, FactSet, Financial Data and Analytics Powered by Tomorrow. Thank you, our panelists. And most importantly, I guess, thank you our audience for joining us over this time. Again, the replay will be on our YouTube page. Have a wonderful afternoon, everybody.