A Last Minute Blast Keeps The Party Going
Remember those somber predictions about 1996 being the year corporate earnings would get a reality check? Well, try to forget 'em. In the year that profit growth was supposed to grind to a halt, it never stopped accelerating.
Earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard blasted expectations. Helped by a 33% fourth-quarter gain, corporate profits grew at a 14% pace, making 1996 the fifth straight year of double-digit returns. Sales rose 11% in the fourth quarter and 9% for the year.
COST-CUTTING. The strong finish is particularly impressive considering how the year began--with a quarter of flat profits and a sharp drop in capital-spending growth as interest-rate hikes kicked in. But then the sun came out again. Consumer confidence grew, executives regained the assurance they needed to boost capital spending, and companies kept eking out cost-cutting gains. The shocking result: another good year and the strongest quarter for profit growth since the end of 1994. "The widely heralded earnings growth slowdown just didn't happen," says Allen L. Sinai, chief global economist at Primark Decision Economics, an economics consulting firm.
True, the fourth-quarter comparison was helped by the unusual number of large write-offs that hampered earnings at the end of 1995. And the 14% growth in 1996 profits, while healthy, was the slowest rise since 1991. BUSINESS WEEK economists think double-digit gains will be harder to achieve this year, as gross domestic product growth slows to a 2.6% pace from 1996's 3.4% and generates a slight pickup in inflation.
But if there is one signature element of this boom, it's how much of it has been fueled by Corporate America. Profit margins actually grew from 6% in 1995 to 6.1% last year, and return on equity was 16.8%. ROE has hit 16% or better for eight straight quarters. Corporate profits made up about 9% of GDP last year, up from 6.4% in 1990, says John Ryding, chief economist at Bear, Stearns & Co. "We're looking at the highest share of corporate profits in the overall economy since the '60s," says Ryding. Still, that share will likely drop this year, as wages start to climb and a strong dollar begins to depress exports. "Something, someplace has to give," says David M. Blitzer, chief economist at Standard & Poor's Corp.
CRUDE SURPRISE. Leading the charge in 1996 was the energy industry, which earned $11 billion more than it did in 1995. Exxon surpassed General Motors and General Electric to become the biggest-earning company in the U.S., with annual profits rising 16%, to $7.5 billion, from sales that grew 9%, to $119.7 billion. One reason for the boost: a runup in crude-oil prices, thanks to unexpectedly tight supplies. Profits in the telecommunications sector also soared 116%, to $10.1 billion. But much of that gain came from AT&T, which had a stunning $2 billion write-down in 1995.
Drug companies were another big winner last year, thanks to new-product approvals and an increased usage of medication. Earnings in the sector rocketed 78% in the fourth quarter and 28% for the year. Says analyst Jack P. Lamberton of NatWest Securities Corp.: "Health-care providers are increasingly realizing that [drugs] significantly lower overall health-care costs, and they are utilizing more of them" in place of costlier hospital stays. With two hot drugs--cholesterol-fighter Pravachol and Glucophage for diabetes--Bristol-Myers Squibb Co. led the way. Its 1996 earnings rose 57%, to $2.9 billion, on a 9% sales jump, to $15.1 billion.
The aerospace industry made the most radical turnaround, more than doubling its 1995 profits and ending last year $4.7 billion in the black. That's due to healthier airlines, which ordered lots of new planes. Boeing Co. more than doubled its commercial jets sold in both 1995 and 1996, and it shows: 1996 profits nearly tripled, to $1.1 billion, on sales up 16%, to $22.7 billion.
Wall Street's breathtaking 1996 bull market had a huge impact on financial services companies, whose profits swelled by 32% last year. One standout: Merrill Lynch & Co., which saw its earnings rise 45% in 1996, to $1.6 billion. And as the Internet stampede continues, software companies pulled in $1 billion more in profit than they did in 1995. But the Internet wasn't the only reason. "Why is the software industry so strong?" asks analyst Michael K. Kwatinetz at Deutsche Morgan Grenfell. "In a word: Microsoft." The computer giant earned $2.5 billion in 1996, up 35%, on revenues rising 27%, to $9.4 billion.
SPLIT CHIPS. The high tide didn't lift all boats. General Motors Corp.'s tardy rollout of its new line slowed sales. That--plus two costly strikes--dropped profits 18%, to $5 billion, and caused GM to fall from its spot as the top-earning company in 1995 to No.7 last year. It wasn't because of industry trends, either: Red-hot models such as the Jeep Grand Cherokee helped Chrysler Corp.'s earnings skyrocket 75%, to $3.7 billion.
Semiconductors were another Jekyll and Hyde industry, though more Hyde than Jekyll. The group earned $6.5 billion in 1996--$1.3 billion less than in 1995--despite fourth-quarter earnings up 8%. Companies such as AMP Inc. and Micron Technology Inc., selling memory chips and other commodity products, hit the skids. That's because overly optimistic 1995 growth estimates froze chip ordering as companies tried to pare inventories. But Intel Corp.--which saw annual earnings increase 45%, to $5.2 billion, and quarterly profits more than double, to $1.9 billion--helped specialty chipmakers to a strong 1996.
In other sectors, there was plenty of pain. Nearly every basic industry--from forest products to metals--suffered double-digit earnings declines. Those industries face greater international competition and have been unable to raise prices. Still, since demand hasn't faltered significantly, economists say that their underperformance doesn't signal a looming recession.
Some problems for companies that made the bad-news column all year were expected: Apple Computer Inc., with its dwindling market share, lost nearly $900 million in 1996. And America Online Inc.'s overzealous growth and accounting changes helped it lose nearly $500 million. Will these laggards be more common in 1997? Yes--if GDP growth slows as expected. "1997 should be good, but not as good as 1996," says Primark's Sinai, who thinks profits will rise only about 10%. Of course, everyone predicted gloom last year. This is one profit runup that doesn't want to die.