Businesses in the U.S. may struggle to maintain the profit gains of the past three years as cost- cutting opportunities become scarcer and cooling global growth reduces demand, according to economists such as Harm Bandholz.
Commerce Department data released today showed before-tax earnings at U.S. corporations increased by 0.5 percent in the second quarter after a 2.7 percent drop in the prior three months. Earnings climbed 6.1 percent from a year earlier, slower than the pace of the previous two quarters.
Economic growth in the U.S. has cooled, European countries are heading into a recession and China is slowing, limiting opportunities for sales growth. At the same time, waning productivity gains mean American companies will be less able to offset rising costs of raw materials and parts.
“We were maybe a little bit spoiled by the profits we saw in the last one-and-a-half years,” said Bandholz, chief economist at UniCredit Group in New York. “We may now see a normalization. Businesses already cut costs to a significant extent, so they are just looking for higher revenues, which in this environment may not go up so easily.”
Today’s report showed gross domestic product in the U.S. climbed at a 1.7 percent annual rate from April through June, down from a 2 percent gain in the first quarter and 4.1 percent in the final three months of 2011.
Stocks advanced, following a two-day decline in the Standard & Poor’s 500 Index, as the economy grew more than first estimated and investors awaited Federal Reserve Chairman Ben S. Bernanke’s speech in two days. The S&P 500 climbed 0.1 percent to 1,410.49 at the 4 p.m. close in New York.
Companies generated higher earnings during the economic recovery as they reduced costs. Profits as a share of gross domestic product rose to 12.8 percent in the final three months of 2011, the highest level since the 1950s, Commerce Department data show. That number began to ease this year, sliding to 12.2 percent in the second quarter.
Greater efficiency enabled businesses to maintain profit growth even as unemployment in excess of 8 percent kept a damper on demand. Productivity, a measure of worker output per hour, advanced 3 percent in 2009 and 3.1 percent in 2010.
It has since dwindled, growing 0.7 percent last year. Unit labor costs have risen as a result, climbing in the first two quarters of 2012, the first consecutive increases since 2008.
Most of the boost to efficiency came from “speeding up the assembly lines, from squeezing out as much output as possible from the workforce,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC. A lack of investment in technological enhancements and the need to train new hires will probably damp productivity growth, he said.
“The vast majority of productivity gains have basically been wrung out of the system,” New York-based Dutta said.
That leaves revenue growth to bolster profits, a transition that should have already taken place with the expansion in its fourth year, according to Richard Moody, chief economist at Regions Financial Corp. in Birmingham, Alabama.
“In the early stages of a recovery, private growth tends to improve due to cost containment,” Moody said. “This far into a recovery, cost containment would have passed the baton off to revenue growth. We should be past that. You have to ask how long companies can eke out cost savings.”
Ford Motor Co., the second-largest U.S. automaker, and Home Depot Inc., the biggest home-improvement retailer, were among companies that reported second-quarter profit topping analysts’ projections, helped by cost cuts as the slowing global economy dented sales growth.
Sixty-seven percent of the members of the Standard & Poor’s 500 Index beat analysts’ second-quarter profit projections, according to data compiled by Bloomberg. A third beat sales estimates, the smallest percentage since at least the third quarter of 2009, the earliest period tracked by Bloomberg.
Cooling global growth is an obstacle.
The euro area shrank in the second quarter after the worsening debt crisis and tougher budget cuts forced at least six nations into recessions. GDP in the 17-nation currency bloc fell 0.2 percent from the first quarter.
China’s growth slowed for a sixth quarter to the weakest pace since the global financial crisis. The Asian economy expanded 7.6 percent last quarter from a year earlier.
Sales in Europe
“People aren’t buying” cars in Europe, Ford Chief Financial Officer Bob Shanks told analysts July 25, spurring the automaker to reduce spending on advertising and shorten work days in factories in the region responsible for a quarter of Ford’s revenue.
Frank Blake, chief executive officer of Atlanta-based Home Depot, has reduced costs as the housing slump has crimped demand for kitchen remodeling and other big-ticket purchases.
A sales gain of 2.1 percent for Home Depot stores open at least a year trailed the 2.6 percent average estimate of analysts surveyed by Swampscott, Massachusetts-based researcher Retail Metrics.
The weak economic environment is also prompting companies to amass cash instead of investing in ways that will stimulate the expansion, Bandholz said.
Corporate spending on equipment and software rose at a 4.7 percent pace in the second quarter, the weakest since the third quarter of 2009, according to Commerce Department figures.
“It’s not a lack of cash or financial means driving cautious business spending but the uncertain outlook,” he said. “It’s not that companies don’t have the means to spend more money, it’s more the macro-environment.”
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