Monday, December 10, 2007

Profits for US Corporations are Expected to Decline as Consumer Spending Declines

As consumer spending slows the profit of US will decline. Some firms are already seeing this happen. The original article has a number of anecdotal stories. Text in bold is my emphasis. From the WSJ:

U.S. corporate profits are being hammered by the slowing economy and credit-market turmoil, intensifying concerns that the nation may be headed for recession.

Banks and other financial companies, which have taken huge write-downs on soured bets on subprime mortgages, have been among the most visible casualties. But businesses ranging from makers of artificial hips to surf-wear retailers to overnight-delivery services are also feeling the pinch.

If profits fall far enough, it could discourage capital spending and make companies less willing to hire or retain workers. A hiring slowdown could magnify the downturn and hasten a recession. That's bad news for wage earners as well as those who own stocks.

Weaker profits ultimately translate into lower stock prices, which could further erode the confidence of American consumers, who are already feeling less wealthy as fuel costs rise and their home values decline.

"The recession in reported earnings has already begun," says David Rosenberg, chief U.S. economist at Merrill Lynch & Co. "The underlying cause is a combination of painfully high energy prices and the general lack of pricing power in many businesses, which is starting to crimp margins."

Mr. Rosenberg estimates profits, measured by the operating earnings per share of companies in the Standard & Poor's 500-stock index, fell 8.4% in the third quarter from a year earlier. He expects those earnings to be flat or lower for the next five quarters.

Companies with most of their business inside the U.S. are hurting most. Merrill estimates "domestic earnings," or profits derived from activities inside the U.S., have contracted in three of the past four quarters and have shrunk more than 4% for the year, the worst reading in that gauge since the fourth quarter of 2001.

Most economists expect things to get worse before they get better. "We're facing a tsunami of earnings downgrades next year," says Mr. Rosenberg.

The downturn in earnings started in sectors linked to housing but has spread far beyond. . . .

. . . . . Until recently, strong foreign sales were a saving grace for many U.S. multinationals, offsetting softening markets at home and bolstering overall profits. The weaker dollar played a role by making American goods more attractive to foreign buyers and helping boost the bottom lines of U.S. companies when earnings in stronger foreign currencies were translated back into dollars at the end of each quarter.

But the downdraft in the U.S. economy is now overwhelming those benefits, economists say.

In 2007's first two quarters, S&P 500 operating earnings rose at a high single-digit pace from a year earlier, before dropping into negative territory in the third period. That weakness followed a remarkable growth run: Through the 14 quarters ended with the fourth quarter of 2006, earnings grew at a double-digit pace.

Richard Berner, chief U.S. economist at Morgan Stanley, expects a "significant and lengthy" contraction in earnings, even if the U.S. economy avoids a recession next year. That's because U.S. companies have far more operating leverage now than at any time in the past.

Companies with high operating leverage have relatively high fixed costs, such as retail chains that must pay rent on dozens of stores regardless of how much is sold at each location or a manufacturer with factories full of expensive machines that must be maintained even if they aren't churning out products.

"Because of operating leverage, when the economy really slows down you get a much more pronounced impact on profits and earnings," says Mr. Berner, because company results are hurt simultaneously by lower sales and thinner profit margins. He says if the U.S. economy grows only 1% or 2% next year, overall earnings might slip 2% to 5%. But if growth is lower, say flat to 1%, earnings could fall by 5% to 15%. . . . .

No comments:

Post a Comment