Corporate Profits: What A Difference A Year Makes

Fueled by capital spending, earnings climb 24% over the turbulent 1998 third quarter

For a while there it was touch and go. Wall Street wavered as investors doubted whether Corporate America could keep its parade of higher profits marching along. And it certainly didn't help when some of the bluest of the blue chips stumbled. But sure enough, when the smoke cleared, corporate earnings had scored big once again.

Powered by a surge in the telecommunications and financial-services industries, recovering demand in Asia, and rebounding oil prices, net profits for the 900 companies tracked by BUSINESS WEEK's Corporate Scoreboard rose a strong 24%. The performance came on top of profit gains of 12% in the first quarter and 28% in the second. Sales growth was strong too, rising 12%. That's the biggest such rise since the second period of 1995.

To be sure, many companies had an easy target to beat because of last year's turbulent third quarter. Then, overseas trading losses at big banks and a seven-week strike at General Motors Corp. (GM) contributed to a dismal 4% drop in net profits. Big charge-offs from mergers and restructurings also drove down earnings a year ago. MCI WorldCom Inc. (WCOM) took a $3.2 billion research and development charge, for example, while Merrill Lynch & Co. (MER) wrote off $430 million for staff reductions. Take out those and other one-time events from last year, and operating profits rose a healthy 16%.

How to explain such vigor nine years into an economic expansion? Clearly, consumers still have the spigot wide open as their spending rose 4.3% for the quarter. But companies are also spending like crazy: Capital expenditures rose 21.7%. The U.S. gross domestic product grew at an eye-popping 4.8% pace. And despite record low unemployment, employers did not feel much wage pressure. That, combined with continued strong productivity gains, pushed margins up to 6.3%, from 5.7% a year ago.

EXPORT REVIVAL. Foreign markets also started to rebound last quarter. Demand especially strengthened in Asia, a region that was the downfall of many a corporate income statement in 1998. Goods shipped to Asian nations other than Japan rose 20% during the quarter, compared with a nearly identical drop a year ago, says economist Ian Shepherdson of High Frequency Economics Ltd. in Valhalla, N.Y.

The export revival helped push General Electric Co.'s (GE) earnings up 16% to $2.65 billion, the largest single profit tally in the Scoreboard. GE recorded rising Asian sales of jet engines and plastics. In its aircraft-engines division, operating profits rose 28% on deals such as a nearly $600 million order for engines from Taiwan's China Airlines.

Brokerages and investment banks, too, got a huge boost as overseas markets revived. The strong U.S. equity and debt markets also helped, as did the boom in mergers and acquisitions. As trading revenues nearly quadrupled, to $1.1 billion, Merrill reported $572 million in profits, compared with a loss of $163 million a year ago. Citigroup, too, combined a jump in global lending and trading revenues with cost cuts to book a huge 234% increase in profits, to $2.4 billion.

The auto makers largely have U.S. buyers to thank for their good fortune. Detroit kept waiting for consumer spending to cool, but it never did. Revenues at car and truck companies jumped 21% in the quarter, and U.S. auto sales are expected to top 16.8 million this year, breaking the record of 16.1 million set in 1986. GM, Ford, and others helped spur sales with brisk discounting. But profit margins rose nonetheless. GM made up much of the ground it lost because of its '98 strike, earning $877 million, compared with a year-earlier loss of $309 million.

The top profit performers also continued to increase efficiency. Chevron Corp. (CHV) saw profits jump 26%, to $582 million--its first increase in two years. Like other oil companies, Chevron has OPEC to thank for agreeing to cut production and helping double the price of crude oil since January. But Chevron also has worked hard to improve productivity, and aims to slash costs by 9% this year. Says Chairman and Chief Executive Kenneth T. Derr: "We're running our company for $2.5 billion dollars less today than in 1992."

The biggest individual turnaround came at MCI WorldCom. A year ago, the company lost $2.9 billion because of write-offs from the merger of MCI and WorldCom. In this year's third quarter, it racked up profits of nearly $1.1 billion, helped by cost cutting and strong growth of Internet transmission. Now the company is buying Sprint Corp. (FON), largely for its wireless business. "There are really only two themes in telecommunications that make any difference anymore: One is Internet and the other is wireless," says John Sidgmore, vice-chairman at MCI WorldCom.

INTEL SHOCK. Booming Internet business also drove big gains at computing companies. Sun Microsystems Inc.'s (SUNW) strong sales of Internet servers produced a $271.1 million profit, up 138%. And Dell Computer Corp.'s (DELL) earnings rose 47%, to $507 million, on a 42% sales hike, as the company honed its direct-selling model to consolidate dominance of the PC market.

The situation was much dicier elsewhere in tech land. Xerox Corp. (XRX) saw its earnings fall 11%, to $339 million, as it struggled through a messy reorganization of its sales force. And though many semiconductor companies recovered from their Asian slump, Intel shocked the stock market when it reported 6% lower profits of $1.5 billion. Competition in microprocessors has dampened prices for Intel's Pentium III.

The biggest individual loser was drugmaker American Home Products Corp. (AHP), which lost $2.87 billion in the quarter. AHP--currently locked in a battle with Pfizer Inc. (PFE) to take over Warner-Lambert Co. (WLA)--had to swallow a $4.75 billion pretax charge on its settlement of diet-drugs litigation.

For most companies, though, this is about as good as it gets. That's particularly true for some tech outfits. IBM (IBM) warned last month that its earnings will drop the next couple of periods. Customers are delaying computer buys until Y2K problems pass.

Still, most economists expect strong consumer spending to keep the economy sailing ahead at least through the holidays. Companies will have another easy comparison against a weak '98 period in the fourth quarter. Corporate America stands an excellent chance of closing the millennium on a winning note.

— With assistance by Diane Brady, and David Rocks

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