The results of soon to be released earnings reports for the major record labels loom. Some investors expect the share prices of these major music stocks — Warner Music Group (NASDAQ:WMG); Sony Music Entertainment, a part of Sony Corp (NYSE:SONY); and Universal Music Group, a part of Vivendi (OTCMKTS:VIVHY), which together dominate the recorded music industry — to continue tuning up.

The last quarter produced exciting news for Warner Music, which reported revenue and cash flow increases of 13% and 74%, respectively. Sony also sang from a positive music sheet, reporting nearly 20% year-on-year growth in the quarter. These impressive 2021 numbers carry over from what proved to be a surprising boom year for the major labels in 2020.

Investors may think that the return of touring and live performances will solidify their expectations of sustained growth throughout 2021. But the earnings crescendo may come crashing down sooner than many anticipate.

Investors beware: 2021 may be a major letdown year for music labels.

Drivers for the Big Record Labels

As reported by Rolling Stone late last year, one of the likeliest drivers of these major record label profit surges in 2020 was cutting spending on the artists they represent. This appears to have come mainly due to Covid-19-related touring lapses. Overall reduced promotional activity of artists during the pandemic also contributed.

“The majors are simply releasing fewer blockbuster albums as Covid-19 dominates news cycles and takes a hammer to live music,” Rolling Stone reported. “Fewer big albums means fewer big expenses for the majors, especially in terms of physical goods.”

Rolling Stone’s theory appears correct. When you look at the past five quarters, you find massive streaming deals and targeted purchases of artist’s catalogs for streaming purposes. What you see little of are investments in “physical music” or “artist services.” These are also called live event and promotional expenses. It makes sense that such a change would lead to greater profits for the labels themselves. This is similar to Netflix (NASDAQ:NFLX) feeling the benefit of lowered content creation during the Pandemic.

Universal and Sony do not publish detailed breakdowns of how they curb costs. Warner is required to do so as a publicly traded body. Warner’s cost of manufacturing, packaging and distribution costs for physical albums fell 22% year-on-year. The recorded music marketing expense also tumbled, down 14% from the same quarter in the prior year.”

These numbers suggest that, unlike other segments of the music business — including the artists and venues — the major record labels thrived during the pandemic. However, there is some question as to whether the major labels can continue this profitability once they have to divert money back into their artists. The lessons learned in Covid-19 may lead to the majors being even more selective in which artists they promote.

Reopening’s Effect on Music Stocks

Rising vaccination rates have prompted the easing of Covid-19 restrictions. This will inevitably mean a massive return to touring and artist expenses. Labels may not have an incentive to spend big on these tours. Realistically, touring does a lot more for artists and venues than it does for companies like Warner Music Group, Sony Entertainment and Universal Music Group.

Without government lockdowns to lean on as an excuse to cut overhead spending, they no longer seem to have a choice and will have to begin spending on the artists they represent again.

Expect the demands of artists and venues to be both expensive and uncompromising in the coming touring season. In fact, with so many artists looking to regain revenue streams lost from 2020, this may be one of the busiest and costly touring years in history. This will be a headwind for the profits for Warner Music, Sony Music Entertainment, and Universal Music Group.

Investors should be prepared for potential shifts in the recorded music space. The artists are going back to work. The major record labels will have some decisions to make as to what is the new normal in their relationship with the artist community.

On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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