News: Analysis & Commentary: THE ECONOMY
THE PROFIT PARTY IS GETTING QUIETER
Earnings growth is expected to begin tailing off fast in '98
What a long, straight trip it's been. Out of the depths of the early 1990s recession, U.S. corporate profits entered a seeming Golden Age, driven by forces from the payback of sweeping restructuring to the opening of new markets abroad. And the underpinnings of a continued domestic expansion are firmly in place: inflation is repressed, consumer confidence is high, and real wages are once again rising.
But, first, we have to get through 1998. Even the early returns on the fourth quarter of 1997 are mixed. Despite respectable revenue growth in the quarter, BUSINESS WEEK's flash survey of profits reported through Jan. 21 (page 34) shows earnings flat with 1996. But when all the numbers are tallied, Standard & Poor's DRI estimates, net earnings of U.S. corporations will come in a healthy 11.4% above 1996 levels.
GLOOMY IBM. After that, DRI says, the outlook dims. First-quarter earnings are expected to be up 6.8%, but by the fourth quarter, earnings growth will have gone into reverse, leaving full-year earnings growth at a puny 1.2% (chart). Other forecasters are more optimistic, but the trend is toward slower earnings growth.
Wall Street began fixating on that prospect after bellwether IBM warned in its Jan. 20 earnings report that first-quarter profits could be 14% below the $1.2 billion it earned a year ago. What troubled investors was the breadth of challenges facing IBM--everything from expected one-time expenses to fierce price competition in personal computers to weak Asian markets and currency woes. That sent analysts racing to recrunch numbers on other companies--even after they had cut estimates on dozens of companies that had issued warnings about fourth-quarter results. "Seventy percent of the revisions are downward," the highest in years, says Ben Zacks of Zacks Investment Research.
For now, nobody is predicting a fundamental change in the outlook for the U.S. economy. Strong consumer demand should help businesses from homebuilding to discount retailing. Miami-based builder Lennar Corp. is looking at a strong first quarter and a record '98. "People are confident, they feel their jobs are secure, and the job market is strong," says CEO Stuart A. Miller. DRI figures U.S. domestic consumption will grow at 3.3% this year, equal to 1997. Moreover, says James E. Glassman, senior economist at Chase Manhattan Corp., "if Asia keeps inflation down, it buys you many more years of expansion--well beyond this decade."
But multinationals, export-oriented manufacturers, and companies with high labor content could feel a pinch. Heavy-equipment maker Caterpillar Inc. announced record fourth-quarter and full-year earnings on Jan. 21, but execs gave a decidedly mixed forecast for global sales: slowing growth in the U.S., an upturn in Europe, and trouble in Southeast Asia. As a result, they warned, earnings in '98 are likely to be flat.
Clearly, turmoil in Asia, followed by depressed demand there, are the biggest blows. The fallout from trading losses with Asian counterparts contributed to J.P. Morgan & Co.'s 35% fourth-quarter earnings plunge, announced on Jan. 20. Citicorp, which that day reported a 7.5% gain in fourth-quarter earnings, to $1.1 billion, said Asian turmoil reduced pretax profits for the quarter by $250 million. Chairman and CEO John S. Reed told analysts he does "share as a concern, as I'm sure you do, as to just how the economic activity in Asia will develop."
Suddenly, the cornerstone of corporate strategy in the '90s--that global is good--looks shaky. Consider Coca-Cola Co., which derives 80% of its earnings from outside the U.S. A spokesman says that Coke expects that in 1998, currency translation "will be greater than a 3% hit" to earnings--more than its usual impact.
TIGHT SQUEEZE. The backlash from Asia will spread far beyond companies with direct investments in the Far East. The Asian crisis will intensify global overcapacity across such basic industries as oil, steel, and commodity chemicals--among the weakest earners this year in the Zacks survey of analysts. Asia could spell trouble for technology companies as well. Microsoft Corp. reported quarterly income of $1.13 billion, up 52%, but said earnings will be relatively flat over the next two quarters, in part because of Asia. Richard C. O'Brien, chief economist at Hewlett-Packard Co., sees consumer demand remaining strong for at least six months. Still, "Asia is a shock," he says. Among other things, HP fears 5 million too many printers will be made in 1998 as Asian makers try to export their way out of trouble.
For Detroit, Asia is only part of the profit squeeze. Even as fallout abroad crimps overseas profits, auto makers will battle more fiercely for market share at home. The Big Three are already facing excess production capacity of up to 6 million cars. At the same time, the weak yen and Japanese price-cutting could threaten profits. "As we go through '98...we will be feeling more pressure from the yen and see increased exports from Japan," warns Ford Motor Co. CEO Alexander J. Trotman. Earnings forecasts are mixed. After rising an estimated 46% in '97, General Motors Corp.'s profits will be up just 2.3% in '98, according to analysts surveyed by First Call. Ford, up 57% last year, may see a falloff of 3.1%, while Chrysler Corp., down 24% in '97, may spurt 26%.
There may be hopeful news coming. Many economists and executives feel that the dollar will drift down from its highs against other currencies by mid-year if the economy slows. "I'm not prepared to hang black crepe," insists IBM Senior Vice-President Lawrence R. Ricciardi. Indeed, he and other corporate optimists believe that the Asian picture could brighten as early as mid-1998.
Some companies are making rapid adjustments to the new environment. Northwest Airlines Inc. plans to reduce capacity on such Asian routes as Japan-Hawaii by 10% in the first quarter, and another 13% in the second quarter. And some execs are even hunting for post-meltdown business in depressed Asian markets. "My sense is that Asia has more opportunity than risk," says Sara Lee President C. Steven McMillan, who has three officials looking for production sites in the region.
Meantime, others are redoubling cost-cutting and stepping up new-product introductions. "We will introduce a larger number of new products across every single product line" this year, says Medtronic President Arthur D. Collins Jr. The medical-equipment maker says it's "comfortable" with analysts' expectations that its earnings in the current quarter will rise 18%. Still, for all too many companies, 1998 will represent a detour from a long, straight profit ride.By Richard A. Melcher in Chicago, with bureau reportsReturn to top