Those Glory Days May Be OverKathleen Madigan
For corporate planners hoping the smaller increase in first-quarter profits was just a fluke on the way to another year of 20%-plus earnings gains, the future may be disappointing. As BUSINESS WEEK economists see it, the glory days of double-digit earnings growth may not be around much longer.
Don't panic. Profit growth will still be solid. BUSINESS WEEK projects that corporate operating profits will increase 11% to 12% in both the second and third quarters, down from the first quarter's 16% (chart). That doesn't come close to the 27.5% surge posted in 1993's third quarter--the biggest quarterly gain of this expansion. But the uptrend is certainly on a par with past profit performances at this stage of an upturn.
Going shopping. What will fuel earnings? A stronger economy will help. Gross domestic product should grow by about 3% this quarter and next. That's nowhere near the 7% advance seen in the final period of 1993. But it's a bit better than the 2.6% pace of the first quarter. Even the recent jump in interest rates shouldn't drag down overall spending. Demand for housing and consumer durables, such as cars and appliances, will probably start to slow after this quarter. But with disposable incomes still rising, consumers will simply spend more on services and nondurable items, such as clothing, entertainment, and travel.
Corporate purchasing will also help maintain sales growth. Most companies have not scaled back spending plans even in the face of rising rates. That's because financial officers can use their companies' own cash instead of tapping into credit lines. Given the profit gain, internally generated cash should rise by about 5% this year, the same as in 1993. Companies can also count on a sales lift from Europe as economies there grow stronger in the second half. As in 1993, total corporate sales will likely increase a solid 5%, split about equally between volume and price increases.
Improving productivity will also help profit margins. Unlike the past, though, companies can no longer hold production levels steady and lay off employees to lift output per hour worked. That strategy works only in the early part of an expansion, when companies have a lot of slack in their workforce and capacity. Now that demand is rising at a healthy pace, managers will have to use technology and streamlined production processes to increase output with the same or a slightly higher number of workers. Productivity should improve by 1.2% to 1.5% this year. That's lower than the 1.7% rise in 1993, but it's far better than the 0.9% averaged in the 1980s.
For now, labor costs shouldn't crimp profits. With unemployment relatively high, at around 6.5%, workers haven't made big wage demands. Wages and benefits in private industry rose 3.3% in the year ended in the first quarter, the smallest gain in seven years. But if the jobless rate dips below 6%, as expected by yearend, a push for bigger pay raises may emerge. If so, profits may rise only 6% in the last quarter--making the first-quarter gain look a lot less disappointing.