Spending Cuts No Longer Yield Earnings for US Companies

Monday, 08 Oct 2012 01:42 PM

 

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Profit gains earned through job cuts and factory closings in the absence of a global economic recovery are starting to reach their limit.

Third-quarter profits and sales for the Standard & Poor’s 500 Index probably fell in unison for the first time in three years, according to analysts’ estimates compiled by Bloomberg. Per-share earnings may have dropped 1.7 percent on average after they were little changed in the second quarter. Sales may have slipped 0.6 percent, the data show.

While most companies plan to keep a lid on spending, lower expenses aren’t leading to the same kinds of increases they reported earlier this year. Hewlett-Packard Co., the world’s largest personal-computer maker, already forecast full-year profit that trailed analysts’ estimates, FedEx Corp. cut its annual earnings forecast and Intel Corp. projected lower third- quarter sales, with all three citing softening demand.

“A lot of the earnings growth that we’ve seen has been related to cost reductions,” said Peter Jankovskis, co-chief investment officer for Oakbrook Investments in Lisle, Illinois, which manages more than $3 billion. “Now many of those cost reduction efforts have run their course. Without revenue growth, there is no room for profit to expand further.”

Alcoa Inc., the largest U.S. aluminum maker, kicks off the third-quarter earnings season tomorrow and is projected by analysts to report a 13 percent drop in sales, the biggest drop in three years, on plunging prices for the commodity. That may wipe out per-share earnings, according to estimates.

Further Cuts

The earnings season “may be rather ugly,” based on early reports so far, according to Gina Martin Adams, a New York-based strategist at Wells Fargo & Co.

“While recession in the U.S. is not necessarily imminent, earnings are weakening fairly quickly,” Adams wrote today in a note. For the fourth quarter, companies may struggle to match analysts’ estimates as data indicates U.S. growth is stabilizing at a “depressed” pace, she said.

The U.S. economic slowdown, coupled with a worsening environment abroad, is leading more companies to consider further job and spending cuts. A Business Roundtable survey last month showed 34 percent of U.S. chief executive officers anticipate they will have fewer domestic employees in the next six months. That’s up from 20 percent when the survey was conducted last quarter.

The gloomier outlook reflects “global demand flattening out, particularly in Europe and China,” Jim McNerney, CEO of Boeing Co. and Business Roundtable chairman, said on a Sept. 26 conference call.

CEOs in the survey also projected U.S. gross domestic product will expand 1.9 percent this year, down from a projection for 2.1 percent growth three months ago.

Generally Tough

“The general economy is tough,” William Lynch, CEO of Barnes & Noble Inc., said in a Sept. 25 interview. The largest U.S. bookstore chain released its Nook HD+ tablet computer the next day at a starting price of $269, about half the cost of the entry model of Apple Inc.’s newest iPad at $499. “We’ve made the pricing decisions on these devices accordingly,” he said.

In one sign of economic improvement, the U.S. jobless rate unexpectedly fell in September to 7.8 percent, the lowest since President Barack Obama took office in January 2009. The S&P 500 is also on course for its best annual performance since 2009 after gaining 16 percent so far this year.

Lowering Forecasts

Still, companies may use third-quarter conference calls to trim profit forecasts for the rest of the year, according to Tobias Levkovich, an equity strategist at Citigroup Inc. in New York. Uncertainty over the presidential election and automatic deficit cuts that could go into effect starting in January may contribute to a lack of management confidence, he said.

Concern about the economy should make CEOs “reluctant to overpromise much for the next several months,” Levkovich said in a Sept. 28 research note.

FedEx, the Memphis, Tennessee-based company viewed as an economic barometer because of its global shipments, plans to unveil specifics of a cost-reduction plan at an investor meeting this week after saying in August it will offer workers voluntary buyouts. Hewlett-Packard, based in Palo Alto, California, has announced plans to cut 29,000 jobs by the end of fiscal 2014 to save as much as $3.5 billion a year.

‘Not Dynamic’

U.S. companies dependent on overseas revenue were probably among the hardest hit in the third quarter. General Motors Co., the world’s largest automaker, may report adjusted per-share earnings tumbled 42 percent with falling demand and price cuts in Europe trimming revenue 1.9 percent to $36 billion.

Tiffany & Co., the world’s second-largest luxury jewelry retailer, cut its annual profit forecast in August for a second time this fiscal year. The New York-based company projects sales will rise as little as 6 percent, a third the pace of 2011.

“Revenue growth has matured,” said Stanley Nabi, vice chairman and chief strategist for Silvercrest Asset Management Group in New York, which manages more than $11 billion. “The U.S. is not dynamic. Europe is headed south. Growth in many of the developing economies -- China, India, Brazil and others -- are decelerating. If you put all of these together, you come to the conclusion that heaven is not forever.”

The euro area’s economic slump is deepening, with at least five of the region’s 17 nations already in recession. Last month, economic confidence unexpectedly dropped, service industries shrank and a gauge of manufacturing by Markit Economics showed contraction in that sector as well.

‘Significant Weight’

“Europe is a very significant weight on revenue” for U.S. companies, said Mark Zandi, chief economist at Moody’s Analytics in West Chester, Pennsylvania. “The fallout from the European debt crisis is starting to hit sales and profitability more broadly.”

Nike Inc., the world’s largest maker of sporting-goods, reported on Sept. 27 that its Western European sales tumbled 5 percent in the three months ended Aug. 31 while sinking demand in China put pressure on future orders. Adjusted quarterly per- share profit for Procter & Gamble Co., the biggest consumer- products company, may have slipped 7 percent on sales of $20.7 billion, a decline of 5.5 percent from a year earlier, according to the average estimate of analysts.

In Europe, members of the Dow Jones Stoxx 600 Index are projected to boost profit 1.7 percent this fiscal year, almost a quarter of what analysts anticipated three months earlier, based on data compiled by Bloomberg.

Porsche, Vitamins

Heerlen, Netherlands-based Royal DSM NV, the world’s largest maker of vitamins, announced in August it will cut 1,000 jobs as it works to meet profit goals. Porsche SE, the Stuttgart-based maker of the 911 sports car, said last month it will increase production next year by less than it had earlier projected because of the deteriorating economy.

Earnings at U.S. energy producers may have been among the hardest hit in the third quarter, falling an estimated 25 percent after prices for natural gas and some related liquids tumbled from a year earlier. The drop threatens to drag down the rest of the S&P 500, already under pressure globally.

“There is softness everywhere so it’s going to be hard for corporate profit growth to pick up again until we see stronger growth domestically and abroad,” said Jeremy Lawson, senior U.S. economist at BNP Paribas SA in New York. “That may not happen until we get into 2013.”

© Copyright 2014 Bloomberg News. All rights reserved.

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