Only The Sizzle Is Gone

It takes a licking and keeps on ticking. Like that Timex watch of old, Corporate America's profits machine just won't give up. Even as the overall economy landed with a near-thud in the second quarter, continued strong demand for capital goods and strength in many cyclical sectors propelled profits upward. Earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard rose 19%. While that's well off last quarter's sizzling 30%, the mainspring hasn't wound down yet.

The growth comes despite the fact that the Federal Reserve Board's long-awaited soft landing--engineered by successive interest rate hikes--has arrived. Real gross domestic product grew just 0.5% in the second quarter. The main culprits: a sharp slowdown in inventory buildup, reduced Mexican exports, and poor housing and auto sales. Consumer spending has also slackened.

So far, however, profit growth has merely slowed, not stopped. That's largely because demand hasn't fallen anywhere near as much as the GDP figures would indicate. Sales for the 900 companies rose 13%, to $1.2 trillion, the biggest leap since early 1984. But rather than producing at last year's breakneck pace, companies are adding to their inventories at a slower rate. Nonfarm inventories in the second quarter rose at an annual rate of $30.4 billion, almost half the growth of the first quarter. So earnings remain strong, since many companies are filling new orders from their shelves, without incurring new costs.

Many also continue to benefit from restructuring. Although price discounting prompted by weak consumer spending has eroded profit margins--they hit 6.4%, down from last quarter's 6.5%--margins remain the best in 20 years. And the weak dollar is bolstering profits at such international powerhouses as Coca-Cola Co. and Merck & Co.

TEMPORARY FLATTENING. Where do we go from here? Most expect the economy to pick up again soon. BUSINESS WEEK economists estimate that GDP growth in the second half will run 2% to 21/2%. "The flattening out was temporary," says Morgan Stanley & Co. economist Stephen S. Roach. "It's not indicative of the economy heading toward a premature recession." He and others expect renewed growth to bring slightly higher profits through yearend, though no one expects a return to 1994's peaks.

General Motors Corp. offered a lesson in the benefits of cost-cutting. The No.1 carmaker stayed at the top of the list of BUSINESS WEEK's top 15 profit-spinners. Profits rose 18%, to $2.27 billion on a 9% sales hike, to $44 billion, as margins hit 5.1%, up from 4.8% in 1994. Still, though North American auto revenues improved slightly, margins there remain weak and inventories are building.

At that, GM did far better than its Detroit brethren. High prices and sluggish consumer demand have slowed auto sales since January, forcing all three into expensive rebates. And to make way for the launch of its new Taurus sedan, Ford Motor Co. has heavily discounted its remaining 1995 models, while its use of overseas components also raised costs. The result: Lower profits per vehicle drove Ford's earnings down 8%, to $1.6 billion, despite an 8% gain in revenues, to $36 billion. But Chrysler Corp., which has no meaningful foreign sales to balance the slowing U.S. market, took the biggest hit. Net income fell to $135 million, down 86% from $956 million a year ago. Big incentives to clear bloated inventories and the expensive launch of new minivans slashed profits.

For the cyclicals, things couldn't be more different. Continued strong demand and high prices helped paper, steel, metals, and chemicals chalk up huge gains. Earnings at International Paper Co. more than tripled, to $316 million, on sales up 42%, to $5.1 billion.

The airline industry also proved a winner. Combined industry earnings hit $1 billion, far from last year's puny $3.8 million. Delta Airlines Inc. led, posting profits of $251 million--virtually equal to its second-quarter loss a year ago. The Atlanta-based carrier has shut unprofitable routes, trimmed costs, and enjoyed strong profits on trans-Atlantic routes.

Computer and components makers also were top performers. IBM turned in profits of $1.72 billion, up 149% on revenues of $17.5 billion, a 14% gain. Strong demand for mainframes and services, and continued restructuring provided the key. Booming sales to telecommunications and PC suppliers also kept semiconductor makers hot: Earnings at Texas Instruments Inc. rose 51%, to $278 million, while Intel Corp.'s profits grew 37%, to $879 million.

Elsewhere, the second quarter contained disappointments. As an industry, aerospace ranked among the worst. The biggest loser: Boeing Co., which lost $231 million after taking a $600 million restructuring charge. Despite an upturn in plane orders that boosted revenues 3%, to $5.6 billion, Boeing is still battling to reduce costs. After merger-related charges of $525 million, Lockheed Martin Corp. booked losses of $53 million.

Retailers, too, continue to struggle. For the most recent quarter, industry earnings fell 19%. AnnTaylor Stores, Lands' End, and Toys `R' Us all got hurt by cautious consumer spending. Still, the news wasn't all bad. As consumers gravitated toward value and low pricing, Wal-Mart Stores Inc. saw profits rise 11%, to $553 million. And at Sears Roebuck & Co., revamped merchandise and snazzy ads sent earnings up 14%, to $218 million. With recessionary fears abating, many hope that's a sign consumer spending could again provide the spark to keep profits growing.

Before it's here, it's on the Bloomberg Terminal.