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Companies across the industry have reported weakening sales and player engagement in recent months

Gaming companies have been hit with weakening sales and engagement in recent months, as players returned to real-world pursuits post-pandemic and began cutting back on their spending amid a cost of living crisis.

Console producers, video game publishers and gaming chipmakers across the industry have reported a fall in demand in the latest quarter, challenging the belief that gaming is one of the most recession-proof forms of entertainment.

The slowdown comes after the sector saw a surge in demand and bumper profits during the pandemic, as global lockdowns drove a spike in consumers’ appetite for virtual entertainment and which, in turn, saw dealmaking rise sharply within the industry.

Console makers Sony and Microsoft were the harbingers of a downturn in gaming, posting sales declines from their gaming businesses. Last month, Sony reported a 15 per cent drop in PlayStation engagement year-on-year.

On Monday Nvidia, which is a heavyweight in gaming chip production, reported lower second-quarter revenue because of weakness in its gaming business. Gaming revenue in the second quarter fell 44 per cent from the previous quarter and 33 per cent from a year earlier to $2.04bn.

Strauss Zelnick, chief executive of Take-Two Interactive, the company behind Grand Theft Auto, told investors this week that he does not believe “the entertainment business is recession proof or even necessarily recession resistant”. On Monday it released forecasted sales for the second quarter and the full year which fell short of analysts’ estimates, causing its share price to fall by 5 per cent.

“If you are feeling the pinch of inflation, specifically with regard to non discretionary expenditures like fuel and food, you could imagine that if you’re playing a game, you might choose to spend a bit less or spend a bit less frequently,” said Zelnick.

This month Activision Blizzard, which is currently being bought by Microsoft for $69bn, posted a 15 per cent drop in adjusted sales in the second quarter compared to the same period last year, driven in large part by weaker demand in the console and PC market and a poor response to the latest release of its iconic Call of Duty shooter game.

Meanwhile, Electronic Arts, famous for its Fifa franchise as well as Sims, last week gave a revenue forecast for the second quarter that missed analyst estimates.

As restrictions have eased, the pandemic-fuelled boom for gaming has waned. But it comes amid a difficult economic backdrop, with consumers around the world looking to reduce their discretionary spending in the face of rising inflation.

The biggest impact appears to be on the mobile segment of the gaming market, which has been the focus of dealmaking in recent years. Take-Two completed a $13bn acquisition of Zynga earlier this year, while EA bought a 3D mobile gaming company called Glu for $2bn last year.

EA said mobile bookings were down 2.5 per cent from the previous quarter, with legacy titles — excluding Fifa Mobile — performing quite poorly.

Andrew Wilson, chief executive at EA, told analysts there was one “open question” the industry was facing: “in a world where you can engage deeply without spending, how will we see spending through this period?”

On Wednesday, the game-making platform Roblox, behind Jailbreak and MeepCity, saw its shares slide more than 12 per cent after it reported a 4 per cent drop in net bookings and a slowdown in daily user growth. The company has lost more than 50 per cent of its value since the start of the year.

Roblox’s chief executive David Baszucki refuted the impact of a gaming downturn on the company’s results however, asserting that it is more of a “future human experience platform” than a gaming company and adding “we’ve been through these cycles before, and we’ve been relatively immune to them.”

Game development platform Unity, which is the engine behind over 70 per cent of mobile games globally, lowered its full-year guidance on Wednesday on the back of revenue growth that was slower than previously modelled, and attributed the revision in part to “recent negative macroeconomic factors”.

Groups have also been let down by weak game releases — normally the catalyst behind stellar growth figures — in part because the pandemic unsettled pipelines. EA is still suffering from a weak release of its hotly anticipated Battlefield 2042 game in November, while Take-Two pushed back one of its most significant title releases.

Activision Blizzard has also struggled after its flagship title Call of Duty received a lacklustre reception late last year, which it attributed to the choice of a second world war setting that failed to resonate with its audiences.

“For growth to accelerate in the industry, you need compelling games,” said Neil Campling an analyst at Mirabaud Equity Research, noting that audiences have become more selective now that they have a more diverse option of leisure pursuits. “In reality we are still waiting for the next must-have blockbuster game.”

Patrick O’Luanaigh, chief executive of NDreams, a virtual reality publisher, agreed there has been a “marked slowdown in big releases”, adding: “It’s relatively sparse which is frustrating for some people.”

Nonetheless, executives have sounded a positive tone about their mid to long term prospects, pointing to steady growth in the number of gamers worldwide.

Wilson from EA highlighted how an expansion into mobile gaming, irrespective of whether they are opting for free games right now, “represents a way for us to access players in markets that our traditional business does not”, pointing to an estimated 3.5bn players worldwide.

Zelnick agreed, noting that evidence suggests the next generation of gamers are “more engaged and they play more”.

“So I have to believe that interactive entertainment will continue to grow disproportionately to the rest of the audiovisual entertainment businesses”, he added.

Ambienta investing in pumps as Europe battles severe drought

An Italian asset manager has launched plans to create a European champion for reducing water waste, as large swaths of the continent battle severe droughts.

Ambienta, which invests in private and listed companies with an environmental focus, is stepping up its exposure to groups whose products limit water waste. Although the war in Ukraine has put energy security front and centre for European companies and policymakers, the alternative asset manager has warned that water scarcity risks being overlooked.

“Seventy one per cent of the planet is made up of water but only a small fraction is accessible and renewable,” said Nino Tronchetti Provera, Ambienta’s founder and managing partner. “Already today 10 per cent of the global population lacks access to the water it needs and the figure risks rising to 40 per cent by 2040 if we don’t make the right choices.”

The group, which has €3bn of assets under management, has recently made a series of investments linked to water with the aim of creating a leading European group in the sector.

Last month it acquired Calpeda, a high-tech water pumps manufacturer based in northern Italy, which it is planning to integrate in its water investments holding company, christened Wateralia. Water pumps such as Calpeda’s reduce water dispersion in businesses and households, leading to energy and water savings.

Wateralia also includes Caprari, another Italian family-owned business specialising in water pumps in which Ambienta took a majority stake last year. It now plans to buy more such businesses and increase its exposure to the sector.

Almost half of continental Europe and the UK are currently exposed to severe drought risks, with unusual heatwaves being exacerbated by little rainfall during the winter, according to a study by the European Commission.

Italy is one of the most affected countries with the northern region experiencing its worst drought in decades.

“This is not surprising in a world where economic growth has outpaced the ability of the planet to digest pollution and produce enough resources for everyone,” said Tronchetti Provera. “We need practical solutions to traditional business models. If there are water pumps that allow industries that consume large amounts of water to save some, that’s a good investment.”

According to the UN, half of the global population could be living in regions facing water scarcity by as early as 2025.

Water has emerged as a niche investment theme in recent years, spurred by wider interest in sustainable investing. Global investment companies such as Amundi and Fidelity have launched exchange traded funds on water-related themes.

Ambienta invests through its own hedge fund and by taking stakes in public and private companies, sometimes buying the latter outright.

The asset manager has made over €1bn in revenues across 148 countries since it began investing in 2007. In 2021 earnings before interest, taxes, depreciation and amortisation grew 18 per cent compared with the previous year.

The firm has invested in 54 companies across Europe including in Italy, Germany and France. These countries had many successfully family-run companies that needed outside investment to grow further, said Tronchetti Provera.

One former investee company, German water-based paint manufacturer Oskar Nolte, expanded globally after being bought by Ambienta and is now Sweden’s Ikea’s paint supplier. Water-based paints are significantly less pollutant than the traditional solvent-based ones.

“Companies won’t solve the world’s environmental issues by planting trees or installing solar panels on their roofs,” said Tronchetti Provera. “If you don’t update your traditional industrial processes, the market will eventually sweep you away.”

With shares of the buy now, pay later company down 77% from November, Max Levchin says firm's lending models will set it apart

Max Levchin says the market is wrong about Affirm Holdings Inc., the buy now, pay later company he co-founded a decade ago. It might just take a recession to prove it.

Affirm’s AFRM 6.00% stock is down 77% since hitting its peak in November, compared with a 9% decline in the S&P 500 during the same period. Investors are worried about future costs of borrowing, growing competition and whether Affirm’s borrowers will fall behind on payments during a downturn. The company’s total valuation stands at about $11 billion, down from a peak of $47 billion.

Mr. Levchin is confident that Affirm has safely cracked the code to underwriting more consumers than banks would. Like many lenders, Affirm tightened underwriting standards early in the pandemic. Last year, it began loosening them.

“I can swear on a stack of Bibles or your preferred book of choice, until we get through a full recession, I will get partial credit when I show the numbers that I said I will,” he said in a June interview with The Wall Street Journal. “But once we’re back in a rapidly expanding economy and we’re still here, still lending money, still controlling our delinquencies, I think I’ll get full recognition.”

Affirm is one of the largest buy now, pay later companies in the U.S., offering payment plans that enable consumers to divide the cost over time for purchases big and small, including makeup, clothing, furniture, travel and workout equipment. Walmart Inc. and Amazon.com Inc. are among the hundreds of thousands of merchants that offer Affirm plans to shoppers.

Unlike credit cards, buy now, pay later plans are for a specific item, and the payments have a clear end date. Some plans don’t charge interest, helping to fuel a rise in their popularity over the past few years. Affirm said it doesn’t charge late fees.

Affirm grew rapidly in recent years while touting its ability to approve more people who might be shut out by traditional lenders, including those with limited or no credit histories. The stock closed Friday at $39.19, up from a low of $14.63 in May but still well below its peak of $168.52 in November.

Mr. Levchin said investors are lumping in his company with other fairly new fintechs despite big differences in their overall lending models.

Affirm underwrites consumers based partly on their credit reports and scores. It also analyzes other information, including where they are shopping and what they are trying to buy. Items such as jewelry are potentially more prone to fraud, because a buyer could resell it at a profit and then default on the loan. Furniture and other big items that are used every day tend to be lower-risk.

The company typically charges merchants higher fees if they want Affirm to approve somewhat-riskier consumers. Those who miss a payment on an Affirm plan typically can’t be approved for another one until they have caught up. Riskier borrowers or those financing an expensive item can be required to make a down payment on an Affirm loan, but others can walk away with a new mattress for $0 down.

Affirm has been offering more payment plans for small-ticket purchases. That move, as well as easing underwriting standards since last year, helped increase Affirm’s volume growth—and placed the company at the center of mounting concern regarding consumer credit. While missed consumer-loan payments overall have hovered near record lows for much of the pandemic, they recently began rising at a sizable clip at Affirm and other fintech lenders.

Rising interest rates are another challenge. Because Affirm isn’t a bank, it can’t fund itself with deposits. Instead, it relies on securitization deals, warehouse lines mostly from banks and selling loans to a range of investors, including insurance companies and asset managers. About 20% of its funding has variable interest rates, the company said.

Cushioning the impact of rising rates and delinquencies is that most of its payment plans are short-term, according to Affirm. They range from six weeks to five years, but average five months.

The stakes are high if delinquencies surge. Affirm borrows from roughly 20 banks, pension funds and other companies, and its most-conservative lenders generally require that its three-month average for payments that are late by at least 30 days doesn’t exceed 6%. That figure was around 2% as of May, up from roughly 1% during its 2021 fiscal year, and in line with where it was prepandemic.

That is “my primary thing that I watch like a hawk,” Mr. Levchin said.

Competitors include Afterpay, Klarna Bank AB and PayPal Holdings Inc. Some big banks have introduced programs that look like installment plans. Mr. Levchin said Apple Inc.’s recent decision to enter the sector confirms that these types of payment plans will gain more traction.

Affirm remains committed, Mr. Levchin said, to the same broad vision it had when it launched: to chip away at credit-card use. “I think the biggest ill in this world is revolving credit,” he said.

A slowdown in retail sales could pose another challenge, especially since buy now, pay later firms often charge merchants higher fees than credit-card companies do. Merchants also have to pay more to offer Affirm payment plans that charge no interest, especially when rates are rising.

Mr. Levchin said merchants and manufacturers will continue to want the Affirm plans as a way to boost their sales.

“In a recession,” he said, “0% is very attractive.”

Volvo dips in to Europe’s ‘seized up’ bond markets

Truckmaker borrows €500mn, a rare case of raising funds at a time when deals have dried up far beyond the summer norm

Swedish manufacturer Volvo AB surprised investors this week by borrowing €500mn — a rare deal in Europe’s parched corporate bond markets that are pin-drop quiet even by summertime standards.

Investors placed €3.2bn worth of orders for the deal, from the financing arm of the truck and bus maker, whose bond deal was one of just a handful to hit the market in several weeks. The amount raised in European corporate bonds so far this year has fallen to the lowest level in nearly 20 years, down 18 per cent compared to the same time last year. European governments have raised 47 per cent less than the same period last year, according to Refinitiv data.

Equity markets are even more muted. The amount raised from companies hitting stock markets for the first time has plunged by 92 per cent compared to last year, Refinitiv data shows.

The slowdown shows how wobbly markets, a dark economic cloud from Russia and rapidly rising interest rates are all making it tougher for companies to tap markets that have been generous sources of funds for years.

“Primary markets have been quite seized up because of the volatility [and] liquidity has been very challenged,” said Snigdha Singh, co-head of European fixed income, currencies and commodities trading at Bank of America.

Years of low interest rates, exacerbated by the coronavirus pandemic, encouraged a glut of corporate and government debt deals as executives raised new funds and pushed existing debt repayment obligations further in to the future.

But with energy price shocks and global supply chain issues, global central banks’ priorities have shifted from stimulating inflation to hosing it down. The European Central Bank has halted its decade-long bond-buying programme which had acted as a safety net and provided comfort to markets since the financial crisis.

The bank has now lifted interest rates to zero, ending a decade of negative rates and following the US Federal Reserve in increasing borrowing costs.

As the ECB has removed its safety net and recession looms across Europe, investors have shied away from funding riskier corners of the market. The amount raised by the lowest-rated, high-yield companies has plunged 79 per cent so far this year compared to the same period in 2021, according to Refinitiv.

“We had a pretty substantial pipeline late spring [but said] ‘let’s put down the pen’,” said Tomas Lundquist, head of European corporate debt capital markets at Citi, adding that “in May and the beginning of June, the confidence level that we had to get the best possible pricing wasn’t that high”.

Additionally, the rush of bond market activity over the past two pandemic years meant that “most companies had already termed out debt and didn’t have imminent funding needs”, he said.

Volvo’s move was more opportunistic. Lundquist at Citi, which led the deal, said the truckmaker’s timing was “very good” after US inflation data was somewhat tamer than investors had feared and that the company “reacted very quickly when they saw this attractive window”.

That has underscored bankers’ reliance on central bank policy to underpin activity for the rest of the year. Investors and analysts are trying to navigate the uncertain outlook using new data releases, aiming to paint a picture of whether and when inflation will cool and to forecast the trajectory of major central banks’ interest rate changes.

US inflation rose by 8.5 per cent year on year in July, a slower increase compared with June and a lower figure than economists had anticipated — raising hopes that the pace of price rises in the world’s biggest economy has peaked.

The data had been closely watched by investors searching for clues about how far the Fed will raise interest rates to curb rapid price growth.

Markets feel “on a slightly firmer footing” now compared to July, one banker said, “with some more stability and even some new corporate deals in Europe [in August]. There is more optimism.”

Equity markets may be slower to rebound. The valuation of companies that listed in the market frenzy over the past two years have been slashed. For example, food delivery service Deliveroo’s valuation has plunged to about £1.7bn from more than £5bn when it listed in London last year. That has put off fund managers.

“Companies that were contemplating [listing] are taking time to see how things settle, and sellers may also need to adjust valuation expectations,” said Tom Johnson, co-head of European capital markets at Barclays.

“After a market fall there is always a bit of ‘who wants to be the first to step off the pavement?’ A lot of issuers would prefer to see data points from other people first.” 

Debt bankers remain more positive and say they are encouraged by recent bond market rebounds. Total returns from Europe’s riskiest debt is down almost 10 per cent this year, but returns have recovered by over 6 per cent since a low in June, according to ICE Bank of America data. An index tracking higher grade debt has also recovered by over 5 per cent since a June trough.

Bankers are hopeful that a couple of successful deals might encourage more to jump in.

“We should not underestimate the herd mentality,” said Josh Presley, managing director at Credit Suisse. “One good deal will open the door for others to follow.”

Companies say quickest way to reduce costs for households would be to move burden to tax

Energy suppliers including British Gas, Eon and Octopus have called on the UK government to move a swath of charges from customer bills into general taxation as they face growing pressure to lower soaring costs for households.

With UK gas and electricity bills forecast to reach as high as £5,000 a year next spring, four times the level before the energy crisis, suppliers have argued that the quickest way to reduce the hit to households would be to strip out many charges unrelated to the rising price of wholesale gas.

Greg Jackson, chief executive of Octopus, the UK’s fourth-biggest energy supplier, said energy bills had become a “catch-all basket” for charges ranging from support for poorer homes to levies to support investment in renewables.

Wholesale gas and electricity costs currently account for just 57 per cent of the typical dual-fuel annual bill of £1,971 under the price cap, or around £1,077, according to regulator Ofgem. The rest — almost £900 — is made up of transmission costs, the standing charge and a plethora of other fees.

Companies have long argued that some of these extra charges are necessary but also regressive as they hit the poorest households hardest. They say that some would be better paid for through tax, which would put more of the burden on higher earners.

“For decades, whenever a scheme is announced, the cost is loaded on to bills,” Jackson said.

“These costs are now making high energy bills even higher, and need to be slashed as part of market reforms.”

Eon, which is also calling for an energy efficiency drive, has calculated that moving various charges into taxation and cutting VAT could lower bills by more than £420 in October, when the UK’s energy price cap is expected to rise to around £3,500 for a typical household, from £1,971 today.

That is more than the planned £400 in support being provided by the government to all UK households.

The £420 total includes £176 in VAT (if bills reach £3,500), £153 for social and environmental levies, and removing the £94 cost per household of transferring customers from dozens of failed energy suppliers.

The proposal would trigger an estimated £10bn-£15bn cost to the taxpayer.

Chris O’Shea, chief executive of Centrica, owner of the UK’s largest supplier British Gas, said it was “unfair” how charges were structured.

“Funding environmental costs through the bill means every customer pays the same amount, regardless of how rich or poor they are,” he said.

The total savings on bills could surpass £500 if the cost of the temporary nationalisation of Bulb, the biggest of the failed energy suppliers, was paid through tax rather than spread across all households as expected next year.

The call from suppliers, which have also backed additional government support to the poorest households, comes after electricity generators were summoned to an emergency meeting with prime minister Boris Johnson and cabinet colleagues this week, which sought solutions to an energy crisis that threatens to trigger a deep recession.

The meeting did not yield any decisions but people who attended have said there were “creative” proposals to be examined in the coming weeks. No decisions are expected until after the Tory party leadership vote in early September.

Electricity generators, particularly those not reliant on gas for power generation, are worried that they could be hit with a windfall tax on excessive profits to help fund additional support for households. They have seen revenues soar as gas has pushed up power prices, while the cost of generating electricity from renewables and nuclear has barely risen.

Wholesale gas prices, driven to about 10 times normal levels by Russia restricting supplies following its invasion of Ukraine, are by far the largest driver of soaring household energy bills.

They could make up around 80 per cent of the total by the spring if bills approach £5,000 as predicted.

Household bills also include around £300 of transmission and network charges, which the energy suppliers are not suggesting be moved into general taxation.

Campaigners such as Fuel Poverty Action are calling for the abolition of the so-called standing charge, which adds around £371 a year to bills for connection to the energy networks, regardless of whether any gas or electricity is used.

Both Tory leadership candidates Liz Truss and Rishi Sunak have indicated that they would suspend VAT from household bills. Truss has also said that she would remove environmental levies. Sunak has indicated that he believes that households will need additional support this winter.

Longer term, energy suppliers are pressing for the electricity price to be decoupled from the cost of gas to better reflect the impact of renewables on the market.

“The UK has a single wholesale electricity price every half-hour — usually set by the price of gas,” said Jackson. “So even if cheap renewables are in use this doesn’t filter through to consumers, which is bonkers.”

A government spokesperson said: “The high global gas prices and linked high electricity prices that we are currently facing have given added urgency to the need to reform Britain’s electricity market. We are already consulting on a wide range of options for reform — including decoupling clean energy from the marginal gas price — and will carefully consider the impact of options on consumers and suppliers.”

Amid rising interest rates and a tightening credit market, companies with weaker balance sheets are getting squeezed by higher borrowing costs.

Royal Caribbean Group RCL +1.56% (ticker: RCL) is a case in point. The cruise operator had $5.5 billion in short-term debt at the end of June, but $2.1 billion in cash. Royal Caribbean just issued $1.15 billion worth of convertible notes to cover some of its current debt, pushing their maturity from 2023 to 2025. But it comes with a higher interest rate—6% instead of the retired debt’s rates of 4.25% and 2.875%.

However, the firm’s operating cash flow turned positive last quarter and CEO Jason Liberty said he plans to get the company’s balance sheet back to what it was prepandemic. The company couldn’t be reached after multiple requests for comment.

To fight inflation, the Federal Reserve has raised its benchmark interest rates by 2.25 percentage points since March. That could spell trouble for higher-risk issuers that need to refinance debt or borrow more.

“Not only do these issuers generally have fewer funding options, but growing risk aversion amid market volatility and rapidly shifting financing conditions could exacerbate their refinancing risk and funding costs,” wrote S&P Global Ratings analyst Evan Gunter in a recent report.

Already, bond issuance for junk-rated issuers has dropped 75% in the first half of 2022. The amount of distressed debt—junk-rated bonds trading at yields 10 percentage points above Treasuries—jumped to $116 billion in July from $26 billion just two months ago, according to S&P. That suggests that the credit market is growing uneasy about debt repayment.

If the economy worsens, companies could see earnings wilt, further straining their cash flow. Companies that have trouble getting loans might be forced to sell equity, diluting shareholders. In a worst-case scenario, a company could become insolvent.

To find companies at risk of a liquidity squeeze, Barron’s screened for those whose cash balance has shrunk by more than half from a year ago. Among those, we looked for companies with short-term obligations—including debt and fixed rent payments—that are higher than their cash balance and one-year earnings combined.

After further narrowing, we identified seven companies worth watching: Royal Caribbean, party-supply seller Party City PRTY 0.00% (PRTY), home-goods retailer Bed Bath & Beyond BBBY +21.83% (BBBY), drugstore chain Rite Aid RAD +4.44% (RAD), fashion retailer Express EXPR +3.81% (EXPR), and footwear companies Wolverine World Wide (WWW) and Caleres (CAL).

The retail sector is a sore spot. Retailers depend heavily on consumer demand and often don’t have enough pricing power to pass the higher costs on to consumers, says Neha Khoda, head of loan strategy at Bank of America Merrill Lynch.

Bed Bath & Beyond faces declining sales and is posting losses as consumers spend less amid rampant inflation. It doesn’t help that the company has spent more than $1 billion on share buybacks since 2020. Bed Bath had $108 million in cash as of May, down from $1.1 billion a year ago.

While most of Bed Bath’s debts don’t mature until 2024, it needs to pay $335 million in rent next year. Bank of America analyst Jason Haas warned that the retailer could face a liquidity pinch if vendors ask it to pay for the merchandise on shorter terms.

Bed Bath still has $1 billion available in its revolving credit facility, a company representative told Barron’s. “We have already taken actions on many fronts—including a reduction of at least $100 million of [capital expenditure] against the company’s original plan,” he noted in an email.

Party City has $39 million in cash as of June, with $350 million in debt and rent payments due in a year. The retailer’s earnings for the past 12 months were $95 million, down 20% from a year ago.

“Despite the continued macroeconomic factors impacting our business, we feel comfortable with our current liquidity and feel it is sufficient to run the business,” said CFO Todd Vogensen on the latest earnings call.

Party City has $157 million available in its revolver and other levers at its disposal, said Vogensen, such as cutting capital expenditures and delaying projects. It also intends to raise $22 million from current creditors.

Rite Aid has little debt due until 2025, but its short-term lease obligations, at $574 million, loom over the $56 million cash balance as of May. In the past four quarters, the company’s earnings slid 18% from a year ago.

“Paying down debt is a top priority for our company,” said CFO Matthew Schroeder in the recent earnings call. The company is exploring additional sale-leaseback options on its owned stores and expects to have proceeds from them later in the year.

Rite Aid also plans to use up to $150 million of its $1.7 billion in revolver availability to buy back outstanding bonds at a discount. The move will bring some interest savings in the future, according to the firm, as the revolver loans have a lower rate.

Express, Wolverine, and Caleres also have high short-term obligations and low cash on account, but all have seen improving earnings in recent quarters. The three companies either declined to comment or didn’t respond to a request for comment.

If the economy goes into recession, more companies will face pressures. Says S&P’s Gunter: “The longer conditions remain this tight, the greater the risk that vulnerable issuers, regions, or sectors could feel the squeeze.”

Earnings season has been far from perfect, but it’s been just strong enough to keep stocks rallying.

For starters, companies have beaten profit expectations. Roughly 90% of companies in the S&P 500SPX +1.73% have reported second-quarter earnings, and the aggregate earnings per share result for companies on the index has beaten expectations by 5.2% as of Wednesday, according to Credit Suisse. That’s in line with the average quarterly beat since 2016.

But earnings results are backward looking, and still-high inflation plus rising interest rates are eating into consumer demand, dimming the earnings outlook from here.

That’s showing up in companies’ guidance. As of Wednesday, 61% of the companies issuing third-quarter earnings have provided outlooks below expectations, according to FactSet. That’s just above the five-year average of 60%.

Analysts, too, have become more pessimistic on future profits. The aggregate S&P 500 earnings estimate for 2023 has dropped almost 3% since June, according to Evercore, to $245 per share.

Yet stocks have largely risen through the negativity. The average stock reaction the day after a company beats on both sales and earnings has been a gain of 1.3% as of Wednesday, according to Evercore. That’s above the five-year average of a 0.9% gain. The average move after a firm misses on both the top and bottom lines has been down 2.7%, less than the average drop over the last five years. Meanwhile, the S&P 500 is up about 15% since its mid-June intraday low for the year, which came just before earnings season began.

That’s because stocks were already cheap—reflecting a more negative scenario—heading into earnings. The S&P 500’s forward price/earnings multiple bottomed at just over 15 times in mid-June from over 21 times at the start of the year. That meant before earnings season, stock prices were reflecting the possibility of a much lower steam of future profits, so stocks have been able to gain even after slight cuts to forward estimates.

“Going into earnings season, expectations, whisper numbers had gotten extremely negative,” said Sevens Report’s Tom Essaye. “That created a very low bar that the results surpassed.”

The positive market response to earnings, to be sure, hasn’t applied to every stock. Nvidia (ticker: NVDA) and Micron Technology MU +4.36% (MU) both lowered their earnings outlook, citing weakening demand for chips and saw their stocks fall significantly in one day. Target TGT +1.70% (TGT) and Walmart (WMT) also cut their outlooks, citing markdowns on discretionary items, causing their stocks to plummet.

The retail sector has been hit hard on fears of rising inflation, a pullback in consumer spending, and a possible recession.

The Dow Jones U.S. Retail Index is down 19% this year, and it’s a similar story in Europe. The Stoxx Europe Total Market Retail index is down 28.7%.

But JD Sports Fashion (ticker: JD.UK), has a record of thriving in downturns. The British sportswear retailer—which sells footwear and apparel from brands including Nike NKE +1.73% , New Balance, The North Face, and Under Armour UAA +1.83% —could buck the latest trend, with the stock estimated to more than double in price.

Shares have tumbled 25.6% to 1.34 pounds sterling ($1.61) in the past six months, but analysts at broker Investec INL +1.55% see a 123% rise to £3. Investment bank Peel Hunt PEEL 0.00% has a price target of £2.50.

JD Sports delivered solid positive underlying sales growth in 2009—during the global financial crisis, the toughest macro period in the company’s history—according to Graham Renwick, an analyst at broker Berenberg.

He said in a recent note that JD Sports became the best-performing stock in his coverage, with the shares rising about 180% in 2009, or 42% across 2008-09.

“There is a sense of déjà vu in the setup for 2022,” he wrote. “History shows that it is more resilient in downturns than investors currently believe.”

JD Sports earlier this month appointed a new CEO, French retail executive Regis Schultz, after longstanding executive chairman Peter Cowgill departed in May over corporate-governance issues. Fresh leadership and tighter regulatory controls should be seen as a positive.

Analysts largely think the retailer, which also owns the Duffer of St. George and McKenzie brands, is misunderstood. They say JD Sports shouldn’t be compared with rivals, because its key customers are between 16 and 24 years old—a group that is obsessed with the latest brands and isn’t encumbered with mortgages and other financial commitments. The company’s strong relationship with leading brands also means it can sell exclusive merchandise at full price.

“JD understands better than anyone what our core sports-fashion-focused and ‘street’ consumer wants,” interim CEO Kath Smith said in a statement. “Our laser focus allows us to curate and deliver the right product offering for this audience.”

JD Sports has a market value of £6.7 billion and employs more than 67,000 workers. It operates 3,360 stores in 34 countries. It trades at a multiple of 10.5 times this year’s expected earnings, a 10% discount to its peers.

The company posted pretax profit of £947.2 million for the 52 weeks ended Jan. 29, more than double the £421.3 million in 2021. Annual revenue was £8.6 billion, up from £6.1 billion in 2021.

The company is conservative with projections, forecasting flat 2023 earnings in line with the 2022 performance. Cost inflation can be offset by passing along price hikes to customers, say analysts Eleonora Dani and Clive Black at Shore Capital. The company “is tightly managed with excellent cash generation, tight stock and cost controls,” they wrote in a note.

JD Sports has a record of scooping up rival retailers—it took an 80% stake in Greek shops group Cosmos and bought U.S. footwear retailer Shoe Palace. Simon Irwin, an analyst at Credit Suisse wrote in a recent note that JD Sports “will continue to be seen as the consolidator of choice by the brands.”

He estimates that the company will have a significant war chest of £1.7 billion in a year, adding, “We believe that M&A will continue to be a significant route for growth and value creation.”