3 Safe Earnings Plays for a Risk-Off Market

Key Points

• With Pepsi stock 9% off its peak, the risk-reward looks favorable.
• UnitedHealth will likely show good Q3 earnings growth.
• NextEra Energy Inc. is poised to deliver a positive earnings surprise.

As we approach the third quarter earnings season, Olympic high jumpers are feeling relieved while limbo artists are stressed. 

Translation: the bar is set really low.

For Q3, S&P 500 companies are expected to collectively report 2.9% higher profits than a year ago. According to Factset, this would be the weakest growth in two years. 

Make no mistake — the anticipated bottom line growth is nothing to sneeze at. When you consider that cost inflation wreaked havoc on corporate income statements this summer, cranking out some profit growth is respectable.

Yet with investors increasingly bracing for a recession and the major indices near 2022 lows, the market is firmly in risk-off mode heading into earnings. What does this mean to earnings traders?

It means taking a swing at highly volatile technology and economically-sensitive names is a risky move. Alternatively, veering toward defensive sectors with more predictable revenue streams feels right in this environment. Here are a few names to consider.

Will Pepsi Beat Q3 Earnings Expectations? 

PepsiCo Inc. (NASDAQ: PEP) reports before the market opens on October 12. Wall Street research firms will be looking for EPS of $1.84, which represents 3% year-over-year growth. More importantly, it would mark a slight slowdown in profitability from last quarter, when Pepsi reported an EPS of $1.86.

However, the consensus forecast is one that may prove overly conservative. For starters, Pepsi often exceeds Street earnings as it did handily last quarter. Q2 organic revenue growth surprised to the upside led by strength in Latin America, where sales soared 22%. While the market initially reacted negatively, the report (and a bear market rally) catapulted Pepsi shares to an all-time high —a refreshing contrast to the 52-week lows many stocks have been setting.

If Pepsi is going to beat again, it will likely have to come from the revenue line. That’s because the company faces a mix of cost challenges that are well-telegraphed by the Street and will make surprise margins difficult. Soda and snack input costs, packaging and freight expenses are all trending higher, not to mention the impact of the strong dollar.

Even with ambitious cost cutting initiatives in place, resilient consumer demand will probably have to save the day for Pepsi this time around and will show if people are trading down to cheaper private label brands. With the stock 9% off its peak, the risk-reward looks favorable here.

How are UnitedHealth’s Profits Doing So Well?

Since we need health insurance regardless of how healthy or unhealthy the economy is, UnitedHealth Group Incorporated (NYSE: UNH) is a good defensive earnings bet (not to mention a solid long term investment). Unlike most large caps, UnitedHealth’s Q3 earnings growth is expected to be pretty darn good. 

The $5.43 consensus EPS estimate not only implies 20% growth over last year but a small improvement over Q2. Even the slightest profit growth acceleration deserves a lot of credit in this market. 

As the country’s largest managed care outfit, UnitedHealth Group has a pair of growing businesses. Its core health care benefits unit serves an expanding list of employers, municipalities and individuals in need of reputable health plans. 

Then there’s the Optum segment, which provides a range of health care services including the OptumRx pharmacy benefit management (PBM) and the OptumInsight analytics service. Optum revenue climbed 18% last quarter, outpacing the 12% growth in the core business.

At the same time, UnitedHealth’s margins are expanding. Part of this relates to declining COVID-19 medical expenses but also historically low costs for emergency services and pediatrics. Better yet, acquisitions are being effectively integrated to lower costs and expand services.

Having multiple growth segments and expanding margins is a rarity in today’s inflation-plagued economy. UnitedHealth beat EPS estimates last quarter and is positioned to do so again when it reports October 14. 

What Can Investors Expect From NextEra’s Q3 Report?

NextEra Energy Inc. (NYSE: NEE) is another somewhat non-cyclical company poised to deliver a positive earnings surprise as it did for the year’s first two quarters. 

In Q2, the electricity provider had one of its best bottom line performances in years as EPS grew 14% and that was despite a 44% surge in natural gas expenses. Gas prices spiked in August before falling the rest of the quarter, so it’ll be interesting to see how much NextEra’s key energy generation input weighs on profits.

On the demand side of the equation, consumers’ pain is NextEra’s gain. The company’s four-year rate plan became effective this year and is slated to raise the average residential customer bill by about 3% annually through 2025. While the pace of rate hikes remains below the national average, it should benefit the former Florida Power & Light’s revenues and growth investment.

A leader in renewable energy generation, NextEra plans to devote much of its profits to wind, solar, and infrastructure projects. By the end of 2025, management plans to triple its renewables and storage capacity. Progress in this regard would alleviate its nearly 20,000-megawatt backlog. 

In the near term, much work lies ahead to repair damage from the Hurricane Ian tragedy in its home state. But since these headwinds will mostly impact Q4 results, look for the Q3 report to provide some relief for the stock’s recent downtrend.