Profits Ease Off From White Hot To Simmering

Third-quarter earnings rose 9% from last year, powered by strong consumer spending

It ain't over till it's over. That was true in this year's World Series, and it's true of this run of bull-market profits. Although earnings are definitely slowing from the double-digit peaks that were seen early this year, Corporate America has not run out of steam yet. In the third quarter of 1997, earnings for the 900 companies on BUSINESS WEEK's Corporate Scoreboard were up 9% from the year before, to $89.2 billion. And thanks to an economy showing surprisingly strong growth, sales increased 10%, to $1.4 trillion.

Indeed, remove a few big losses, and it would have been another double-digit quarter. Without Boeing Co.'s abysmal performance and shortfalls at DuPont Co. and Lucent Technologies Inc., earnings overall would have been up 13%. "Consumer income is rising, job insecurity is gone, and capital spending has surpassed the peak of the 1980s," says Rosanne M. Cahn, chief economist at Credit Suisse First Boston. "I think profits and revenues will continue to grow at about the same order of magnitude through next year."

The combination of low inflation and strong consumer spending powered most of the growth. While inflation remained a quiescent 1.4%, consumer spending roared ahead at 5.7%, the fastest quarterly pace in five years. The spending spree helped gross domestic product chug ahead at an annual rate of 3.5% during the quarter, up from 3.3% in the spring. Corporate America also continues to do its part: Bolstered by rising capacity utilization, capital spending grew a healthy 18.7%.

Of course, the good times can't last forever. Economists predict that GDP growth will slow to 2% in 1998, as a weaker stock market, higher interest rates, and lower Asian exports are expected to take hold. And despite current demand, price hikes remain nearly impossible to push through. That means companies will have to continue efforts to eke out efficiencies to keep margins up. Margins remain at near-record levels--although down slightly, at 6.2%, from the 6.7% racked up in the first quarter of the year.

Who were the big winners? General Electric Co. topped the list. GE's profits rose 13%, to $2.01 billion, thanks to strong exports and sales of spare parts and services by GE's equipment units.

STARS OF FINANCE. Among all industries, savings and loan associations improved most, with earnings up 280%. The biggest change came from H.F. Ahmanson & Co., an S&L in Irwindale, Calif., which made $95.5 million, up from a $79.5 million loss in 1996. Acquisition-related charges, along with lower credit costs, fueled the gain.

But S&Ls weren't the only finance stars. Insurance companies boasted a 78% boost in profits. Leading the way was Hartford Financial Services Group, the former ITT Hartford. It roared back from last year's loss of $543 million--largely due to a big charge for asbestos and environmental coverage--to post profits of $299 million. A close second was Allstate Corp., which rode a strong domestic underwriting performance to its best quarter ever. Profits rose 182%, to $824 million. And, hardly surprising, the bull market also juiced up income in financial services. At Morgan Stanley, Dean Witter, Discover & Co., earnings rose 51%, to $678 million, while Travelers Group Inc., parent of Smith Barney Inc., saw profits jump 39%, to $823 million.

Semiconductors were another winner. Profits for the group rose an even 100%. A turnaround at Texas Instruments Inc.--which saw earnings hit $239 million after a loss of $179 million a year ago--helped, as did another strong quarter at Intel Corp. Profits at the powerhouse increased 20%, to $1.57 billion, thanks to telecommunications equipment sales and strong demand by PC makers.

Prospects for the software and services sector seem dim: Profits fell 16%, to $1.8 billion. But most of the downturn came from a one-time charge of $426 million at 3Com Corp., which merged with U.S. Robotics Corp. in June. The result: a loss of $146.8 million. And Oracle Corp. took $167 million in acquisitions-related charges, depressing earnings to $8.5 million, down 92% from last year. But strong demand helped Microsoft Corp. earnings rise 8%, to $663 million--accounting for more than one-third of the industry's overall profits.

STOP AND GO. Detroit, too, was a mixed bag. Ford Motor Co. came out ahead. Earnings grew 64%, to $1.1 billion, on a 6% sales gain, thanks to hefty cost cuts and strong sales of popular models such as the Ford Expedition and the Lincoln Navigator. The picture was also rosy at General Motors Corp. With no strikes this year, with trimmed manufacturing costs, and with production back up after a year of model changes, GM turned in its best third quarter ever on an operating basis. Though net income fell 16%, to $1 billion, last year's third quarter earnings were inflated by a reduction in plant-closing reserves.

At Chrysler Corp., however, things were dimmer. Higher rebates and a changeover to new models such as the Concorde cut profits 35%, to $441 million.

IN A STEEP CLIMB. The auto maker was not the only former highflier to stumble. Boeing shocked its investors with a $696 million loss, the quarter's biggest. Even more stunning was the reason it offered: Demand has grown so sharply that the company is losing money struggling to turn out aircraft fast enough.

Telecommunications turned up two of the quarter's biggest losers. Lucent Technologies took a $597 million loss. After buying Octel Communications Corp., it had to write down $945 million of Octel's ongoing R&D expenses. Meanwhile, the heavy spending needed to move into local phone markets, combined with a drop in its long-distance business, left MCI Communications Corp. $182 million in the red.

Chemicals were another laggard, with industry profits falling 41%. The main culprit: giant DuPont, which lost $17 million after earning $898 million a year ago. Though acquisition charges hurt most, stiff competition also contributed. "Selling prices have declined, so you have to constantly drive productivity up and drive costs out of the system," says Kurt M. Landgraf, DuPont's CFO. For the quarter's winners as well as its losers, that trend will continue.

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