Earnings: It's Gonna Get Ugly

The global crisis isn't going away--and U.S. profits will suffer

The emerging-markets crisis has settled in for an extended stay. Around the world, markets are drying up, prices are contracting, and economic development is slowing. And with the major industrialized nations still putting together a rescue plan, there is no sign of improvement on the horizon.

Much of the U.S. economy remains unscathed, but the deepening crisis has become an immense challenge for American business. "The world economic crisis is front and center of what we're thinking about," says General Motors Chairman and Chief Executive John F. Smith Jr.

As companies close the books on the third quarter, the extent of the damage will become clearer. Many companies have already issued earnings warnings because of the emerging-markets meltdown and the deflation it is spreading. That has prompted analysts surveyed by First Call Corp. to slash estimates: Now, they project that operating earnings of the 500 companies in Standard & Poor's stock index will fall 1.1%. That would be the first quarterly drop since 1991.

RADICAL MOVES. What are U.S. companies doing to cope? Surprisingly few of them are pulling back from foreign markets. Three or four years from now, overseas markets will again provide the best growth potential, executives say. In the meantime, they are trying to preserve profits--using measures usually reserved for domestic recessions, including layoffs and reductions in capital spending.

A prime example is 3M. For years, it counted on global markets to produce double-digit earnings growth. But 3M's sales, whacked by softness in Asia and the strong dollar, fell 1% in the first half, while profits declined 5%. So on Aug. 27, Chief Executive Livio D.

DeSimone launched 3M's most radical restructuring in two decades. The company is laying off 6% of its workforce, exiting marginal businesses, and taking a pretax charge of up to $500 million.

Similarly, on Sept. 22, Crown Cork & Seal Co. said it would slash 7% of its workforce, cut capital spending, and buy back shares. And the pain is spreading to financial services: Citicorp and Travelers Group Inc. will cut jobs after their planned merger, which won U.S. regulatory approval Sept. 23. Wall Street is bracing for other layoffs as traders tally emerging-markets losses. Already, corporate layoffs are 37% ahead of 1997, say outplacement specialists Challenger, Gray & Christmas Inc..

WHERE'S BOTTOM? Few expected that the Asian meltdown would hit the U.S. this way. Then again, when the crisis erupted last summer, "the prognosis was we might see an 18-month period before recovery," explains Diann H. Painter, chief economist at Mobil Corp. "Now, it looks as if for Asia, we're looking at 2 to 2

1/2 years of very slow to no growth."

The problems have since spread, threatening Latin America. If Brazil collapses, warns GM Chief Economist G. Mustafa Mohatarem, the U.S. auto industry--and many other companies--will be hit far harder than in Asia. In all the emerging markets, fear is inhibiting consumers, adds Gillette Chairman and CEO Alfred M. Zeien, who admits, "I don't know where the bottom is."

Ever-bullish Wall Street analysts insist that the third quarter will mark the bottom. Indeed, analysts surveyed by First Call still project a 10.3% jump in profits for S&P 500 companies in the fourth quarter, and 19% next year.

But those are "pie-in-the-sky estimates," scoffs Charles L. Hill, First Call's research director. Indeed, the gap between economists' expectations and these forecasts is "as striking a divergence as I've seen in 20 years," says economist Robert J. Barbera at broker Hoenig & Co. At best, we'll see a single-digit jump in U.S. corporate profits next year, predicts Nariman Behravesh, chief international economist for Standard & Poor's DRI. And if the Latin economies tumble, earnings will go "into negative territory."

If that happens, far more companies are going to "have to think about cutting back," warns Hill. And those cutbacks could brake the 7 1/2-year-old U.S. expansion. Even DRI's best-case scenario assumes layoffs will drive the U.S. unemployment rate to 5.5% next year, up from 4.5% now. Similarly, U.S. capital spending "will be hurt pretty dramatically," warns Behravesh. At best, DRI expects capital spending to grow by 6% next year, down from a double-digit rise in 1998. If the global economy worsens, growth in capital spending could slip to less than 3% next year and then decline in 2000.

Meanwhile, the effects of the global crisis are spreading far more deeply than Corporate America expected last fall. Initially, the damage was confined largely to commodity businesses and certain sectors of manufacturing, such as heavy-equipment makers. But imports are depressing prices of everything from steel to autos in the U.S. "As economies crash around the world, everyone seeks to export to the land of the free," complains GM CEO Smith. GM is now offering huge incentives to keep up with rivals. Mazda Motor Corp. has slashed $5,550 from the sticker price of its Millenia S. Ford Motor Corp., meanwhile, has cut the base sticker price of the '99 Taurus by $1,000.

"CASH CRUNCH." Companies are increasingly cutting back their capital-spending plans. Morgan Stanley Dean Witter analyst Jay Deahna expects chipmakers to pare their capital spending by 35%, or $14 billion, this year--a staggering blow to makers of semiconductor equipment such as Applied Materials Inc., which has already announced a major layoff. Motorola Inc. has postponed an entire $3 billion chip plant. "In this market...you get into a cash crunch," says U.S. Steel Group President Paul J. Wilhelm. U.S. Steel has already idled mills in Gary, Ind., and Loraine, Ohio.

To be sure, not every industry is scaling back--or needs to. "We're having the best year in 20 years," says David Seiders, chief economist for the National Association of Homebuilders. Interest rates are low, and the Asian crisis has reduced lumber prices, he notes.

And virtually everyone still sees enormous opportunities in emerging markets long-term. Short-term, some companies are trimming their sails. On Aug. 20, Federal Express Corp. announced that it would put its Asian expansion plans on hold. And Polaroid Corp. recently stopped all of its shipments to Russia.

Still, retreat is the exception. At Corning Inc., the Asian recession and the weak yen have cut prices for the company's core product by 30%, says CEO Roger G. Ackerman. "But we're not backing down," he says. "Our strategy is to fight like hell." To cut costs, Ackerman has instead reduced Corning's salaried head count by some 600, or 10%. Indeed, some multinationals, such as Wal-Mart Stores Inc., see this as an ideal opportunity. Wal-Mart remains "committed to being more of a presence in [Latin] markets," says CEO David Glass. "What we are learning is how to operate in volatile economies."

Indeed, the crisis is teaching executives to view globalization more warily. "Many U.S. executives were too naive," says Harvard business school professor Rosa-beth Moss Kanter. "Asia and China were really overhyped." Going forward, companies will have to be far more realistic aboUt the promise--and peril--of emerging markets.

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