Corporate Profits: `Things Still Look Awfully Good'

Growth may be slower--but at this pace, it's more likely to last

America's longest-lasting postwar economic boom is beginning to look more like a marathon than a sprint. The pace may have slowed, but the race appears far from over. In the second quarter of 1997, earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard rose 7% from a year earlier, to $89.3 billion, on an 8% sales gain, to $1.4 trillion. Eliminate a huge $1.73 billion write-down-related loss by drugmaker Eli Lilly & Co., and profits would have risen 10%.

Although second-quarter profit growth slowed for the third year in a row and margins, at 6.4%, are below the first quarter's record 6.7%, it's hard to find a pessimist. "Things still look awfully good," says David A. Wyss, research director at DRI/McGraw-Hill. "In the seventh year of an economic expansion, this is phenomenal."

Even the bad news doesn't seem that bad. The second-quarter slowdown was caused in part by the consumer, who pared big-ticket items, such as autos, and focused on paying the tax man. Growth in consumer spending fell to just 0.8%, from 5.3% in the first quarter. But most economists think shoppers were just taking a breather. Consumer confidence remains high, and the unemployment rate fell to 4.8% in July--tying May for the lowest rate in 24 years.

Likewise, growth in real gross domestic product slowed to a moderate 2.2% annual rate in the second quarter, down from a robust 4.9% rate in the first quarter, but economists seem more concerned about too much momentum than they are about a slowdown. And rightly so--in July, there were signs that the economy was picking up again. A National Association of Purchasing Management index that measures the outlook for inventories, jobs, and production hit 58.6%, from 55.7% in June.

"GREAT SHAPE." With the same already solid basics--a roaring stock market, healthy income growth, and strong productivity increases--the economy looks capable of overcoming anything, including a strengthening dollar and rising tide of imports. BUSINESS WEEK economists think the economy will rebound in the second half, with annualized real GDP growth above 3%. Bruce Steinberg, chief economist at Merrill Lynch & Co., expects a 13% boost in profits this year for the companies in Standard & Poor's 500-stock index. "The bottom line is that the economy is in great shape, and there is no obvious imbalance in it," he says.

Atop BUSINESS WEEK's list of second-quarter winners was Ford Motor Co., which made $2.5 billion. That's an industry record, and a gain of 33% from the $1.9 billion it posted a year ago. Sales, meanwhile, climbed 3%, to $40.3 billion. How did Ford rev up earnings? Cutting $1 billion in costs helped, as did Ford's hot new Expedition sport utility vehicle. Unlike last year, Ford won't stall in the third quarter, says Chairman and Chief Executive Alexander J. Trotman. "I'm very confident we'll see a good second half," he says.

Ford's rivals didn't fare as well. General Motors Corp. and Chrysler Corp. were both hurt by softening car sales, increased Japanese competition, and strikes, which held auto makers' profit gains to just 4% for the quarter. GM's profits were flat, at $2.1 billion, while Chrysler's earnings fell 53%, to $483 million. Chrysler's labor problems are behind it now, but workers at nine of GM's plants still lack contracts.

Consumers may have been counting their pennies, but businesses spent with abandon--especially on technology. The software, hardware, and semiconductor industries all had powerful quarters. Demand for Office 97 and Windows helped push earnings at Microsoft Corp. up 89%, to $1.06 billion, on a 41% sales increase, to $3.18 billion. Dell Computer Corp. showed growth in both sales and earnings, which rose 58%, to $2.6 billion, and 141%, to $198 million, respectively.

That red-hot growth already may be cooling, though. Microsoft said that Office 97 sales were slowing. And while Intel Corp.'s performance led semiconductor companies, with earnings up 58%, to $1.65 billion, on a 29% sales gain, to $5.96 billion, it barely met expectations. Demand for its older Pentium chips is falling fast, and Intel is facing price pressure from Advanced Micro Devices Inc. and others. On July 25, Salomon Brothers Inc. analyst Erika Klauer lowered her 1997 Intel earnings estimates from $7.65 billion to $7 billion.

The good news was more widespread among insurers. A relative dearth of natural disasters and ongoing consolidation led to a banner quarter. Travelers Property Casualty Corp., 84% owned by Travelers Group Inc., saw earnings rebound, to $276 million, from a $220 million loss resulting from charges related to the 1996 purchase of a unit of Aetna Inc. Transamerica Corp., which sold off its consumer finance unit for a $275 million profit in the quarter, saw earnings shoot up 266%, to $388 million. And although brokerages faced what Michael A. Flanagan of Financial Service Analytics called "killer comparisons" with last year's second-quarter profit rise of 49%, they tacked on another 10% gain. Profits at Merrill Lynch & Co. rose 11%, to $481 million, on sales up 29%, to $8 billion.

Few of the airline companies flew as high. Despite strong demand and steady capacity, solid gains were hard to come by. Also hurting comparisons: a federal ticket tax that had lapsed for the first eight months of last year. Northwest Airlines Inc. posted the biggest decline with earnings of $136.2 million in the quarter, down 33%, on sales up 1%, after jet overhauls raised maintenance costs.

A new-product bonanza helped most drugmakers post a strong quarter. But it wasn't enough to offset Eli Lilly's $2.4 billion write-off of its $4.1 billion purchase of pharmacy benefits manager PCS Health Services in 1994. That cut the sector's profits by 40%, even as sales climbed 9%. The telecommunications industry suffered too. Earnings tumbled 24% on a sales increase of 8%, owing partly to a $1.6 billion charge from SBC Communications Inc. related to its merger with Pacific Telesis Group. Long-distance companies AT&T, Sprint, and MCI Communications also took some heat, as smaller, nimbler rivals grabbed share. AT&T's earnings fell 38%, to $959 million, on sales of $13.2 billion, up 2%. "Telcos are having a hard time coping with deregulation," says Rosanne M. Cahn, chief economist at Credit Suisse First Boston. "They haven't figured out that they can still cut costs."

They're the exception. Most of Corporate America has settled into a rhythm of slow and steady profits. While this quarter's numbers may not add up to an economic sprint, a slower-paced marathon lasts a whole lot longer.

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