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PROFITS: AND YOU THOUGHT LAST QUARTER WAS BAD
Asia's woes--and resulting cheap imports and lost sales--drag U.S. profits down further
For months, Corporate America braced for a Pacific tsunami. And in the summer, it crashed ashore. From razors to polyester to paper, U.S. producers saw sales disappear in Asian markets and prices sag at home in the face of cheap imports.
The bottom line: Profits for the 900 companies on BUSINESS WEEK's Corporate Scoreboard dropped 4% in the third quarter from a year earlier, on a 7% sales rise. That contrasts with a 9% net-profit gain in the corresponding quarter of 1997, and it marks the worst performance since the final three months of 1995. On the operating level, things weren't much better: Even without one-time charges and special gains, profits for the Scoreboard companies fell 2%. "In the third quarter, the profits recession became clear-cut," says Allen Sinai, chief global economist for Primark Decision Economics.
The misery extended far and wide. A glut of crude oil cut earnings 48% in the coal, oil, and gas industry. Another type of overcapacity, in computer chips, sent semiconductor profits down 45%. Surging imports of cheap steel chopped profits for that industry by 22%.SHRINKING MARGINS. Profit margins were caught in a vise of falling prices and rising wages, which were up 3.7% from a year earlier. Average margins for the 900 companies shrank to 5.6% from 6.2% the previous year. Worse, that's the first time since mid-1994 that margins have dropped below 6% for two quarters in a row. And there were signs that the slowdown might stick around for a while. U.S. gross domestic product grew 3.3%, down from the 3.7% pace of the first half. For 1999, BUSINESS WEEK's economists project a GDP gain of just 2%.
The biggest individual money-loser last quarter was MCI WorldCom Inc., which dropped a staggering $2.9 billion because of write-offs it took to merge MCI Communications Corp. and WorldCom Inc. Without the MCI WorldCom loss, the Scoreboard profits would have been down only 0.3%. General Motors Corp., which recorded an $809 million net loss after taking a $1.2 billion hit on two summer strikes, also skewed the overall figures. But even without the strikes and a loss on the sale of some parts businesses, GM would have reported 28% lower earnings. The culprits included economic problems in Latin America and higher costs of switching over to a new generation of trucks.
The rest of Detroit's Big Three fared much better. In part, that's because Ford and Chrysler are ahead of GM in cost-cutting. But their new trucks are also already racking up sales. Chrysler Corp., in its last release before merging with Daimler Benz AG, boosted profits 55%, to $682 million, on sales up 16%, thanks largely to its Dodge Durango. And though Ford Motor Co.'s net income fell 11%, to $1 billion, on sales down 10%, sharply lower costs lifted operating earnings 10%.
A closer look at a couple of multinationals shows the breadth of the overseas woes. DuPont Co.'s net losses swelled to $564 million, more than double a year earlier. While DuPont was hurt by a $1.3 billion charge related to the purchase of a drug joint venture, its fibers sales also were slammed by cheap Asian imports. Likewise, Gillette Co. was nicked by weak foreign markets, high costs for its new Mach3 razor, and a $535 million restructuring charge. In the quarter, net income fell to $6 million from $437 million in 1997. CEO Alfred M. Zeien says this global downturn is "different from anything we've experienced in the last 20 to 30 years."
Despite the tough environment, some companies managed to score big gains. General Electric Co. led the profitability pack yet again, recording earnings of $2.28 billion, up 13%. It combined relentless cost-cutting with strong sales in many of its units. AT&T, meanwhile, cut 15,000 employees and nearly doubled profits, to $2.1 billion, on only a 4% increase in sales. Another bright spot: Wireless sales surged 19% on the success of AT&T's Digital One Rate plan.
Many companies found a haven in still-exuberant U.S. consumers. Consumer spending grew at 3.9%--down from the galloping 6.2% pace of last summer, but still robust. Shoppers displayed an increasing tendency to spend wisely. Thus, while retailers' profits grew 70%, much of the hottest action was in discount stores. Kmart Corp. pushed profits up 158% to $80 million, thanks in part to cost-cutting. Sales increases were thin--only 3% total--but spread across apparel, pharmacy, and other product lines.
With most companies facing a pricing squeeze, the push was on to boost productivity. That meant more investment in computers and software. Software sales jumped 24%, while profits gained 81%. Microsoft Corp. again led the pack, driving sales up 26% but posting an even more impressive 154% increase in profits, to $1.68 billion. Strong sales of Windows 98 helped, but the gain also reflects a $296 million write-off taken a year ago to buy WebTV Networks Inc.
The turmoil in overseas financial markets cut a chunk out of several big brokerages and banks. BankAmerica Corp., the coast-to-coast operation formed by the merger of NationsBank Corp. and the old BankAmerica, said its earnings were dragged down by a $529 million trading loss, mainly in Russia, and a $372 million charge-off to cover its investment in D.E. Shaw & Co. Citigroup, the combination of Citicorp and Travelers Group, reported its Salomon Smith Barney brokerage arm took an aftertax loss of $700 million on global arbitrage and Russia-related credit losses. Travelers' net income--reported separately for the quarter--fell 81%, on 17% lower revenues. Russian trading losses also battered Bankers Trust Corp., with a net loss of $488 million.
Of course, if the stock market continues to rebound, consumers may gain enough confidence to save Christmas and pull profits out of the slump. Interest-rate cuts by the Federal Reserve could help. And the resulting weaker dollar should also make U.S. goods more competitive overseas. Still, executives have learned that their overseas woes aren't going away anytime soon.By Steven V. Brull in Los Angeles, with bureau reportsReturn to top