Strong Earnings Reports Make These 3 Large Caps Buys

As we approach the halfway point of the fourth quarter earnings season, there have thus far been two takeaways. According to Factset, 1) companies are beating earnings per share (EPS) estimates at an above-average rate, and 2) the magnitude of the beats has been below average.

So, while the first trend is clearly positive, the second may be cause for concern. The likely culprit? You guessed it: Inflation.

As prices from grains to fuel to transportation continue to climb, businesses are having a harder time passing on escalating costs to customers—and producing the big blowout quarters we often see for the holiday period.

There have been outliers, i.e., companies that have well exceeded the long-term average earnings surprise of roughly 9%. Those that did are worth a closer look as buys because if they can outperform in this challenging economic backdrop, there’s a good chance they’ll really outperform as inflationary and supply chain pressures improve.

These three large caps recently reported big positive earnings surprises—and probably have more in store.

Is Caterpillar Stock Undervalued?

Caterpillar (NYSE: CAT) reported Q4 adjusted EPS of $2.69 which was up 27% year-over-year and topped the analyst consensus by 19%. The substantial beat was accompanied by double-digit sales growth in all three of the Dow component’s operating segments.

The Construction Industries business saw sales jump 27% due to higher volumes and better pricing. Even a slowdown in demand from China couldn’t derail the unit’s strong performance as management noted increasing demand for construction equipment in the Latin America and EMEA regions.

Top line growth was identical in the Resource Industries segment which benefitted from robust mining activity (tied the surge in commodity prices). Revenue growth in the Energy & Transportation division was a more modest 19%. There are a pair of key growth drivers to keep an eye on here—oil & gas equipment demand and power generator demand from data center customers.

Management said it expects higher sales in the current quarter but softer margins as a result of higher materials and transportation costs. The Street is expecting 17% earnings growth for all of 2022 which means there is significant value in Caterpillar at 14x forward earnings.

Will Southwest Airlines Be Profitable in 2022?

Given the turbulence in the travel industry, expectations were low heading into Southwest Airlines’ (NYSE: LUV) Q4 report. Still, the low-cost airliner was able to deliver earnings that were roughly twice what the Street was prepared for. Better yet, it marked the company’s first profitable quarter of the post-pandemic period.

Southwest Airlines received a lift from strong holiday travel demand. This showed people are getting more comfortable with boarding planes despite the extra safety hurdles and recent spate of cancellations. Southwest flights operated at 81% capacity during the quarter compared to 54% in Q4 of 2020. It also got a solid contribution from its new co-branded credit card business which it recently launched to generate supplemental revenue.

The Q4 earnings beat was particularly impressive considering Southwest faced 80% higher fuel expenses. And as usual, the nation’s most financially fit airline exited the year with a healthy balance sheet that includes $12.5 billion of cash compared to $10.2 billion of long-term debt.

Management did say it expects to swing back to a loss in the current quarter due to Omicron-related staffing shortages and inclement weather. On the bright side, however, quarters two through four are expected to profitable as staffing issues moderate and passenger demand climbs. Southwest is trading at 14x this year’s earnings, a price that like its fares, is below that of competitors.

Is Packaging Corp of America a Good Stock?

Packaging Corp of America (NYSE: PKG) beat Q4 earnings estimates by 33% sparking a high-volume gap up in its share price. The containerboard products specialist was able to comfortably exceed the Street’s forecast because of higher pricing and an improved product mix.

In the core Packaging business, which accounts for more than 90% of sales, some 1.24 million tons of containerboard were produced to keep up with rising demand from retailers, meat packers, agriculture companies, and Packaging Corp’s other diverse end markets. The smaller Paper business also experienced strong profit growth.

Given its role in providing boxes and shipping containers across various industries, Packaging Corp of America is a good bellwether of domestic economic activity. With economists expecting more muted growth in 2022, the company could be in for less sizeable earnings beats in the quarters ahead. But considering the stock trading is at 14x forward earnings and offering a 3% dividend yield, Packaging Corp is the full package for large cap value investors.