Profits: Torrid Turns Tepid In The First Quarter

There was no way sizzling profit performance could go on forever. And it didn't

Not long ago, Corporate America was racking up stellar earnings numbers the way Michael Jordan pumps in points--showing few signs of wear, despite having been at it forever. Today? Well, at least Jordan is still going strong. But take out the one-time $16 billion gain Ford Motor Co. booked from the spin-off of its Associates First Capital Corp. finance arm, and net income rose only 4% in 1998's first quarter for the 900 companies on BUSINESS WEEK's Corporate Scoreboard. Sales rose a relatively tepid 7%. Back in 1997's first quarter, net income grew a sizzling 21%--about what you would get for the '98 first quarter if you included Ford's dazzling special gain.

Nor do things look much better on an operating basis. Remove special charges from the 900 companies and the overall gain in profits remained a sluggish 5%. Says Hugh A. Johnson, chief investment officer for First Albany Corp.: "The cards are absolutely stacked against strong profits."

The blah earnings performance is curious, given the overall economy's health. Gross domestic product clicked along in the first quarter at an annual rate of 4.2%, vs. 3.7% in 1997's final period. Inflation is well-behaved, below 1%. Meanwhile, the public is happily dipping into its wallet, with consumer spending rising a robust 5.7% for 1998's first three months. Capital spending, too, has skyrocketed by 17.6%. Low interest rates and a mild winter also yielded a vibrant housing market, with starts up 9%.

But these sunny conditions mask underlying weaknesses, which have hurt profitability in many areas. The strong dollar has hobbled exports and attracted competition from a surge of often-cheaper imports. Asia's economic turmoil has dried up a rich market. Tight labor markets have helped push up wages, even as employee benefits are growing more expensive. Add to that the American public's deep desire for bargains, making price hikes tough for many companies. Indeed, some are slashing prices. Witness the race to sell sub-$1,000 computers.

Those factors are starting to push margins down a notch. As a whole, the Scoreboard companies recorded net margins of 6.4% in the quarter, not including Ford's extraordinary gain. Still, if margins have slipped from 6.6% in the year-ago period, this was still one of the best first-quarter margins in 25 years.

Certainly, not everyone met disappointment. Not counting Ford, the biggest winner for the quarter was General Electric, which reaped the rewards of a booming economy across its product line--from plastics to jet engines to its NBC network--and registered a $1.9 billion profit. The food industry turned in mouth-watering 194% gains, mostly thanks to the turnaround at Quaker Oats Co. After losing $1.1 billion in 1997's first quarter, the sale of its money-losing Snapple operation allowed Quaker to book a modest $47 million profit this year. The strong economy also boosted demand for cardboard and paper containers, allowing several companies to trim losses. That made the industry by far the quarter's most improved, with profits up a stunning 526%. Other winning sectors include construction and real estate, which rode low mortgage rates to a 56% earnings hike. With the economy and Wall Street thriving, financial outfits are also doing well. Among the leaders was Travelers Group Inc., parent of the Salomon Smith Barney securities firm, which posted a 34% increase.

Successful new products powered profits at many drug and medical-product companies. Those industries saw net income jump 18% and 26%, respectively. Warner-Lambert Co. got a lot of mileage out of its cholesterol-lowering drug, Lipitor, sending profits up 37%.

Elsewhere, though, the picture wasn't as pleasant. Black & Decker Corp. took the quarter's biggest hit, racking up losses of $971 million. The main culprit: a $900 million write-off for selling underperforming units.

Or consider Intel Corp., which supplies nearly 9 out of 10 PCs with their microprocessor chips. Earnings fell a breathtaking 36%, to $1.3 billion. The popularity of low-priced computers means Intel is selling more low-end, less-profitable chips--and fewer high-end ones. But Intel also is the victim of the PC-makers' move late last year to build inventory to meet a demand that hasn't lived up to expectations. The industry, laments Intel Chairman Andrew S. Grove, "seems to have gotten ahead of itself."

Read Grove's lips and he's clearly referring to Compaq Computer Corp., the world's largest PC maker. On top of lower prices for new machines, Compaq got hurt because the massive inventory buildup forced it to discount heavily while boosting ad spending. The result: Profits slumped 96%, to a piddling $16 million. The industry's only really good news came from long-suffering Apple Computer Inc. The launch of a well-received new line of Macintoshes helped propel it to a second straight profitable quarter, with $55 million in earnings.

Oil is another industry with pricing problems. A glut of crude caused by Asia's economic woes and a warm winter knocked prices down by a third compared to a year ago. Exxon Corp. experienced a 13% profit dip, to $1.9 billion, despite benefiting from strong chemicals and gasoline retailing sectors.

Demand was strong in aerospace, but the group was dragged down by its woebegone leader, Boeing Co. The company's production lines are snarled by a backlog of airplane orders. Bottlenecks in connection with its next-generation 737 plane alone resulted in a $219 million charge. Boeing's earnings glided downward 91%, to $50 million.

Things were looking much better among Boeing's airline customers, who are planning to expand as they cruise along on a comfortable cushion of rising airfares and low fuel costs. AMR Corp., parent of American Airlines Inc., turned in a spectacular 91% profit increase, to $290 million.

That other big transportation sector, autos, was a mixed bag. Ford, powered by a relentless cost-cutting campaign and a strong showing in Europe, rang up a record $1.7 billion in income before special charges, a 15% gain. The gains came despite a 2% revenue drop caused by intense competition in North American car sales. But at General Motors Corp., net income fell 11%, to $1.6 billion, partly because it sold fewer parts to Asia. At GM and much of the rest of Corporate America, management will have to find a new gear if it hopes to keep profits from stalling out.

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