Canadian companies basking in the glow of soaring commodity prices are expected to deliver double-digit profit gains, though many investors enter the earnings season wary about rising costs.
Canada's first-quarter earnings season kicks off in force this week, with soaring gold , oil and copper prices expected to feed through to the bottom line of the market's many resource firms.
But investors will also be scanning earnings statements for signs those rising commodity prices are feeding through to higher costs and eroding margins. Such a trend could further derail a multi-year bull rally that has started to stumble in recent weeks.
"The Canadian markets show pretty good sequential growth in earnings and certain good year-over-year growth. I'm not expecting any missteps," said Barry Schwartz, a portfolio manager at Baskin Financial Services.
Yet Mr. Schwartz warned many companies are being hit by rising energy and commodity prices and wage pressures that are "going to cause profit margins to weaken unless companies are able to pass on those rising input costs to the consumers."
Blue-chip companies on the Toronto Stock Exchange's S&P/TSX 60 index are expected to report first-quarter earnings growth of 14.4 per cent compared with last year, according to Thomson Reuters StarMine SmartEstimates, with the index trading at just under 11 times forward 12-month earnings.
The materials sector, which includes mining stocks and makes up roughly a quarter of the overall TSX index, is projected to have the highest growth rate, coming in at about 56 per cent higher than last year's earnings.
Oil and gas companies, which make up another quarter of the index, are expected to report growth of just under 13 per cent.
Both bullion and U.S. crude prices have skyrocketed roughly 30 per cent in the last year, while copper prices have jumped about 20 per cent. Solid Canadian economic growth prospects are also seen supporting results.
Yet the boom has also increased demand for labour and equipment used to produce those commodities, which could boost expenses. And the situation could be even tougher for the companies purchasing those commodities.
"If there are companies showing that margins are compressing because they can't pass along these higher input costs ... there's going to be some caution and there could be downward revisions," said Anil Tahiliani, a portfolio manager at McLean & Partners Wealth Management.
Tim Hortons Inc. recently hiked the price of its coffee and baked goods as commodity costs have risen. George Weston , the company behind Weston Foods and grocer Loblaw , also boosted prices to cover rising costs.
Earnings growth for consumer staples companies is projected at just over 6 per cent.
Consumer discretionary companies meanwhile, could also feel the pinch of higher costs, as consumers cut back on spending.
Some companies have softened their outlook, indicating hurdles ahead. Telecom companies, like Rogers Communications Inc. for example, are facing cut-throat competition from upstarts like Wind Mobile and Public Mobile who offer low-cost wireless alternatives.
Some of these concerns have weighed on the Toronto Stock Exchange's S&P/TSX composite index, which finished 0.16 per cent lower at 13,799.12 on Friday. It had touched 14,270.53 earlier this month, its highest level since late 2008. It has since stumbled roughly 3 per cent.
"We had a huge run, and after a huge run, you have to expect profit-taking and a pullback," said Odlum Brown's Murray Leith, a director of research.
While he expects the recovery to continue, he does think the stock market gains of recent years are unlikely to be repeated. The composite jumped nearly 31 per cent in 2009 and 14.4 per cent last year.
A Reuters poll conducted last month showed analysts expect the index to end 2011 at 14,500, suggesting a gain of 8 per cent this year.
Ron Meisels, a technical analyst and president of Phases & Cycles in Montreal, said there's a chance the TSX could correct to around the 13,250 level. That said, he noted that the index's 200-day moving average is still rising and points to money flowing into the market.
"It suggests we're still healthy, we're still in a bull market ... Once this correction is over - or during this correction - people should look for buying opportunities," said Mr. Meisels.
"People should continue to look for strong stocks in the energy and materials and gold sectors."