Third Quarter Profits: So It's Not The Glory Days

Profit growth is slowing, true, but the numbers are still impressive

Is Corporate America's profit machine petering out? Certainly, the party seems to be winding down after the boom times between mid-1992 and mid-1995, when quarterly profit gains averaged more than 30%. Earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard rose 13%, to $82 billion, on sales up 9%, to $1.3 trillion.

Of course, that's a far cry from a bust. As the on-again, off-again economy continued to confuse economists and executives alike, it's the strongest gain since the 19% rise in 1995's second quarter. So call it respectable, if not robust.

Still, there's no doubt that the profit slowdown predicted for months is taking hold. Growth among companies in the Standard & Poor's 500 has also cooled off: For the quarter, operating earnings per share rose just 6%. "There has been a significant slowing in earnings growth," says John Ryding, senior economist at Bear, Stearns & Co., "and it will continue to decelerate."

In part, that's because the overall economy no longer has much pep. Real gross domestic product rose at only a 2.2% annual rate in the third quarter, down sharply from a 4.7% gain in the second. Final demand from consumers, businesses, foreigners, and government was nearly flat. Consumers took a breather from buying big-ticket durables, while Europe and Mexico remained in the doldrums. Instead, almost all of the third-quarter GDP rise came from inventory accumulation.

But other elements are also crimping profits growth. A tight labor market is sending wages up. Yet with inflation tame, most companies can't raise prices much. Consumer prices were up only 2.9% in the quarter, while economywide, prices rose 2%. That's good news, too: Earnings weren't pumped by inflation.

Moreover, having squeezed costs mercilessly, many companies have little left to cut. "Restructuring and cost-cutting, normally reserved for the downside of the profit cycle, were done in an upswing," says Richard Bernstein, director of quantitative research at Merrill Lynch & Co. The end result: Third-quarter margins were 6.3%. That's better than the 6.1% recorded a year ago, though down from the 6.6% in the second quarter of 1996.

TOUGH GOING. The road ahead could get rougher. While companies have enjoyed vigorous profits growth virtually across the board recently, the big gains increasingly appear to be reserved for market leaders such as Intel Corp. and Microsoft Corp. "The higher-quality companies are seeing sustained profit growth," says A. Marshall Acuff Jr., equity strategist at Smith Barney Inc. "But it will be harder, even for them, to maintain it over time."

Certainly General Electric Co., which heads the list of BUSINESS WEEK's top 15 profit machines, knows how to keep growing. GE's profits rose 11%, to $1.8 billion, on sales up 15%. A spate of European financial-services acquisitions, strong results at NBC, and strength in aftermarket services all helped.

Among industries, computer makers appeared the best, with profits up 152%. But exclude a one-time restructuring charge IBM took in 1995, and Big Blue's third-quarter profits were flat, at $1.3 billion. And without IBM, the sector's profits rose just 1%. While Compaq, Dell, and Sun Microsystems all posted big gains, Digital Equipment lost $66 million as rivals hit its corporate customers. Apple Computer Inc. and Hewlett-Packard Co. also struggled.

In semiconductors, too, a tightening market is separating the wheat from the chaff. Thanks to premium prices and the near-monopoly it holds over desktop PC processors, Intel's earnings rose 41%, to $1.31 billion. Elsewhere, though, problems are brewing. After three years of 30%-plus growth, worldwide semiconductor sales will drop 10.5% in 1996, according to the Semiconductor Industry Assn. And factory overbuilding has brought brutal price declines. Texas Instruments Inc. lost $148 million, while Advanced Micro Devices Inc. was $38.4 million in the red.

By contrast, many software makers did well, led by Microsoft, which saw earnings rise 23%, to $614 million. The success of Windows NT, Microsoft's powerful server operating system, is expected to buoy the company. Client-server software and intranet programs should keep up the growth at Netscape Communications Corp. and Oracle Corp.

Detroit's auto makers also showed surprising strength all around. Chrysler Corp. posted earnings of $680 million, a 92% gain, largely due to heavy demand for its popular pickup trucks and minivans. Ford Motor Co. also had a healthy third-quarter profit of $686 million, up 92%. Strong U.S. truck sales, continued cost reductions, and record earnings from financial services made up for losses in Europe and South America.

Even General Motors Corp., which has seen its market share decline from 32.4% a year ago to 31.6%, posted better-than-expected earnings. GM's profits rose 220%, to $1.3 billion, thanks to higher sales volumes and cost-cutting. But GM also benefited from a low 2.8% corporate tax rate. And it added $409 million to pretax earnings by reversing an earlier charge for plant closings.

BACK TO EARTH. Of course, there were big disappointments as well. Following its spin-off from ITT Corp., insurance giant ITT Hartford Group Inc. took a $510 million charge for environmental claim reserves, earning it the spot as this quarter's biggest loser. And the weak pulp market, together with a $350 million pretax charge, gave Louisiana-Pacific Corp. losses of $203 million.

Wall Street has also come back down to earth after two record-breaking quarters. With equity underwritings off 45% and stock exchange volume down 13% from last quarter, profits grew just 7%. Trading losses on proprietary accounts and losses in oil refining and marketing sent Salomon Inc.'s earnings down 58%, to $112 million.

Plenty of other well-known names felt pain this quarter. PepsiCo Inc. saw earnings drop 77%, to $144 million, as it lost ground to Coca-Cola Co. overseas and struggled to fix its domestic restaurants. And Motorola Inc. took a hit as earnings dropped 58%, to $206 million. The once mighty electronics giant has been unable to combat steep declines in pricing and demand for cellular phones and pagers. It's a reminder to all of Corporate America that this profits slowdown may spare no sacred cows.

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