Here Come Those Slow Growth Blues

Yes, '95 profits grew 16%. But their fourth-quarter drop signals a hard slog in '96

Well, we knew it was too good to last. The soaring corporate profits that put 1994 and early 1995 into the record books are now just a memory. It's time to get used to slower growth again.

Earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard slowed sharply from 1994's spectacular 40% gains. For 1995, profits grew at a modest 16% pace. While plenty strong historically--since 1973, annual earnings growth has averaged around 10%--it's unlikely to last. Profits for 1995's fourth quarter fell 6%, the first such drop since the 1991 recession.

Things weren't quite as bad as they might seem, however. Big write-offs at AT&T, McDonnell Douglas, Boeing, and several oil companies accounted for an outsize chunk of the fall. In fact, simply exclude the massive $4.2 billion charge AT&T took to pay for its planned split into three companies, and overall fourth-quarter profits would have been flat.

Still, with the Federal Reserve interest rate hikes that ended a year ago biting into a once-exuberant economy, signs abound that the peak is past. Although sales were up 12% for the first three quarters, growth slowed to 9% in the fourth. And the pincer movement of low consumer confidence and high consumer debt is squeezing spending.

More darkness may be around the corner. Bellwether cyclicals such as paper and steel, which waltzed through early 1995, saw profits decline as much as 57% in the final quarter. Meanwhile, advance orders for semiconductors have fallen sharply: Chipmakers' book-to-bill ratio slid 17% between December and January. After 1994's hot 3.5% growth, U.S. gross domestic product rose only around 1.5% last year. "We've come down from the stratosphere back closer to reality," says David M. Blitzer, chief economist at Standard & Poor's Corp.

BUSINESS WEEK economists believe that GDP in the first half of 1996 will grow at an annualized rate between 1% and 1.5%. The January blizzard bears some blame. But middling home sales and a sharp drop in the growth of capital spending since early '94 indicate that there's more going on than bad weather. Although most economists still don't think the U.S. is heading for recession (box), it's surely coming in for a landing.

LITTLE FAT. Adding to the earnings pressure, companies have much less room to hike profits by paring costs. Just look at composite return on equity: Since 1992, it has zoomed from below 9% to around 16%. That's a testament to increased productivity--and to how hard it will be to find more savings. Indeed, while margins for the year widened to 6%--the highest in two decades--they're moving back down. For the fourth quarter, margins fell to 4.8%. Just as unexpectedly strong demand boosted profitability in the early 1990s, slowing sales will trim margins this year. "It's the exact counter-story to where we were in 1990," says Richard Bernstein, head of quantitative research at Merrill Lynch.

General Motors Corp. headed the list of BUSINESS WEEK's top 25 earners in 1995, with $6.9 billion in profits, a 23% gain, on sales up just 9%, to $169 billion. Although the cost-cutting and productivity-enhancing steps GM began in 1992 have clearly taken hold, the strong performance wasn't enough to save Detroit from a 10% slide in overall profits. For that, blame Ford Motor Co. and Chrysler Corp., the only two companies among America's top 25 earners to show profit declines in 1995. As Ford struggled with heavy costs for new-model introductions in a slowing market, profits fell 22%, to $4.1 billion, on sales up 7%, to $137 billion. Chrysler slid further: Profits dropped 45%, to $2 billion, on sales up 2%, to $53 billion. The bad news for GM? It's launching costly new models this year into an increasingly lackluster market.

CHIP PILES. As an industry, chemical companies raked in the biggest gains. Much of the credit goes to Dow Chemical Co., which saw profits rise 145%, to $1.9 billion, on a 21% sales hike, to $20.2 billion. DuPont Co., too, had a strong year: Profits rose 21%, to $3.3 billion, on sales up 7%, to $42 billion. Both benefited from the red-hot U.S. market early in the year, as well as strong demand from Asia and other developing regions. Yet as the slowing world economy dented fourth-quarter profits growth, 1996 promises to be tougher.

There's already evidence of leaner times ahead among many of last year's top performers. Semiconductors and computers, for example, gained a combined $6.7 billion in new profits during 1995. IBM led the sector with $4.2 billion in profits, a 38% leap. The reason: strong growth in computer services and mainframe sales, plus black ink again at its PC unit. Hewlett-Packard Co.'s profits leapt 52%, to $2.4 billion, as a result of strong PC and workstation sales. But computer makers' profits fell 11% in the fourth quarter. Struggling Apple Computer Inc. and Unysis Corp., which took a $582 million charge to cut jobs and ditch mainframes, were the biggest culprits. And while strong sales of Pentium chips pushed Intel Corp.'s profits up 56%, to $3.6 billion, for the year, its $60 million fourth-quarter write-down reflected the lower value of memory-chip inventory as sales to PC makers slowed at yearend.

Hefty write-offs made losers of some industries even in a generally buoyant year. Aerospace and defense companies did poorly overall. McDonnell Douglas Corp.'s write-off for accounting changes left it $416 million in the red, while Boeing Co.'s $600 million charge for early retirements cut earnings to $393 million even as orders boomed. But the biggest dog was the deregulating telecommunications industry: After its $4.2 billion write off, AT&T's profits slid 97%, to $139 million. Sluggish sales and overcapacity also continued to drag down retailers. It was one more sign that--even putting aside one-time charges--1996 is hardly shaping up to be a party.

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