TBO.com - TBO is Tampa Bay Online

Cuts, Quick Fixes Pad Profit Reports

ADVERTISEMENT

The Associated Press

Published: August 6, 2008

NEW YORK - On the surface, U.S. companies' second-quarter earnings were fairly respectable when you strip away the financial sector - profits for Standard & Poor's 500 members rose about 10 percent from a year earlier after falling sharply the two previous quarters.

Looking more closely, it's clear that companies managed that feat by cutting costs and jobs to cope with soaring commodities prices, a broken credit market and the ongoing housing slump.

Companies can't slash their way to growth, however. So investors are trying to assess companies' well-being by focusing on revenue.

"Right now, they are navigating a storm, but what if that storm turns out to be a hurricane?" said Howard Silverblatt, senior index analyst for Standard & Poor's, said of U.S. corporations. "Companies are able to maintain their earnings and margins, but they're being squeezed a lot. You can only get by for so long - if the economy doesn't get better, the earnings will eventually suffer."

More than 70 percent of the S&P 500 companies have reported results. So far, profit for the entire group is down almost 20 percent from a year earlier. However, remove the banks and brokerages that have suffered massive losses since the credit crisis began last year, and S&P 500 members have seen profit grow by about 10 percent.

Though there's no way to track how many companies relied on one-time gains to beef up their profits, analysts say there's anecdotal evidence that it was higher than usual.

Shipments, Market Share Shrink

For instance, mobile phone maker Motorola Inc. handed Wall Street an unexpected profit, much of it gained through cutting costs. Though sales were up across all of its business units, the company's overall revenue still fell 7.4 percent because of declining market share in its struggling handset unit.

Hanesbrands Inc. doubled second-quarter profit, but analysts said the apparel manufacturer achieved that performance through nonrecurring items and cost cuts. Kraft Foods Inc. surpassed expectations, in part, because of hefty price increases. But sales were hampered by the slowing economy. Is volume, a measure of products shipped, fell 1 percent as some were turned away by higher prices.

Wall Street considers cost cuts and price increases as quite acceptable strategies for boosting profits. But they are something of a quick fix - eventually, companies run out of employees to cut from payrolls and risk losing customers by increasing prices.

Jack Ablin, chief investment officer of Harris Private Bank, said the most important number that professional investors examine is revenue growth. Looking at that in a company's earnings report shows how well the business is doing before one-time events occur.

"You can only shrink so much," Ablin said. "I don't see many areas of the market where we're truly growing. Growing by shrinking is great for a quarter or two, but not a sustainable story."

Relying On Exports

American companies also have been making their numbers the past few years when exports offset sluggish domestic revenue growth. But that cushion could be in jeopardy. There are increasing signs that Europe's economy is slowing and that Asia's could follow.

S&P 500 companies, as of Aug. 1, reported 12.5 percent growth in international sales during the second quarter, while domestic sales rose just 2.6 percent. Goodyear Tire & Rubber Co., for example, reported 60 percent of its revenue came from overseas while domestic sales fell 6 percent.

Wall Street has generally been happy with second-quarter results, in part because analysts weren't sure what to expect. In March, they forecast S&P 500 companies would see earnings rise 0.84 percent. That lackluster number was lowered on June 30, to an estimate of a 9.9 percent earnings drop, and lower on July 28, when the forecast was for a 19.36 percent earnings dive.

Lowering the bar might have made it easier for some companies to beat the projections. Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. were all able to bound past projections, raising hopes they might have a better handle on the credit crisis.

Third-quarter results for the financial companies are as difficult for analysts to predict as they are for companies in other sectors, but mostly because no one has a good handle on how much more in failed mortgage investments the banks and brokerages need to write down. So far, global banks and brokerages have written down more than $300 billion in bad mortgage-backed assets. Merrill Lynch & Co. has disclosed more for the third quarter.

Some on Wall Street feel that using tools like cutting costs and moderate price increases is exactly what chief executive officers need to weather an economic downturn. So far, it appears to be working: S&P 500 profit fell by 25.8 percent in the first quarter, after dropping 30.8 percent in the fourth quarter.

Loading Comments...

Email Print

ADVERTISEMENT