Be Glad the Quarter Is Over

It was a bloodbath for earnings, but shrinking inventories point to a distant recovery

There's blood in the water as the economic downturn continues to gnaw through corporate earnings. Even with an 8% gain in sales, the 900 companies on BusinessWeek's Corporate Scoreboard saw second-quarter profits plummet 52% from a year earlier, while margins fell to 3.2% from 7.2%. That's the largest decline ever recorded in the quarterly scoreboard--nearly twice the 27% year-to-year drop in the fourth quarter of 1991. And the current profit plunge follows a 25% decline in the first quarter. This "near recession," as some economists dub the current slump, is breaking new ground in corporate misery.

Moreover, the pain is now nearly ubiquitous, spreading beyond the already hard-hit technology and telecom sectors to airlines, autos, and steel. "It's a pretty awful environment," says Mark Vitner, an economist at First Union Corp. Despite low interest rates and moderating oil prices, many companies remained squeezed between high labor and energy costs and slowing demand for their products. "Manufacturing is still in the crapper," says Ian C. Shepherdson, chief economist at High Frequency Economics Ltd. in Valhalla, N.Y. With the U.S. economy growing at a meager 0.7%, the second quarter marked nine straight months of slumping industrial production.

RIPPLE EFFECT. Even the strongest sectors are showing signs of weakening. The huge $4.46 billion second-quarter profit that once again made Exxon Mobil Corp. (XOM ) the Scoreboard earnings champ represented a 2% decline from its year-earlier quarter as oil prices weakened. And to generate its typical 15% earnings gain, to $3.9 billion, General Electric Co. (GE ) had to lean hard on cost-cutting. Sales fell 3% for GE as lower ad revenue at NBC, the closing of Montgomery Ward, and an exit from auto-lease financing offset strong sales of gas turbines to utilities. Like most corporations, GE doesn't see a quick recovery. "By the end of January, we recognized that there would not be a rebound in the second half," says Chief Financial Officer Keith S. Sherin.

Tech and telecom remain by far the biggest drags on profits, though. In the second quarter, the computer software and services sector lost $4.7 billion; telecom-equipment makers lost $9.1 billion; and semiconductor manufacturers, $11.2 billion. Moreover, it may take five years to shed overcapacity of fiber-optic cable and other telecom related components, says Blaik Kirby, a tech consultant at Adventis. JDS Uniphase Corp. (JDSU ), which makes chips for digital communications networks, was the biggest loser, dropping $7.9 billion during the quarter and writing off $44.8 billion in assets. That followed a $1.3 billion loss in the previous three months. Former highfliers such as Qwest Communications International Inc. (Q ) are choking on overcapacity. The Denver-based telecom lost $3.3 billion in the quarter, up from a loss of $121 million a year earlier. Network-equipment supplier Cisco Systems Inc. (CSCO ) lost $2.69 billion.

The ripple effect of such losses is scary: The red ink flowed at Lucent Technologies Inc. (LU ), which lost $1.9 billion this quarter, vs. a $286 million profit a year ago. Lucent's recovery plan calls for slashing annual expenses--by $2 billion so far--and eliminating 10,500 jobs. Says CEO Henry Schacht: "The name of the game is to create a new, leaner, faster company."

Not all tech giants are in free fall. IBM's (IBM ) diverse business model and strong relationships with big corporate customers have stabilized the company during the tech slump. These days, nearly half of Big Blue's profit comes from long-term contracts, such as those for managing other companies' computer systems. As a result, IBM was the sixth most profitable business on the scoreboard, with $2 billion in profits, a 5% rise in a sector that saw a 63% profit decline overall.

If there's a glimmer of good news, it's that on the whole, profits aren't expected to decline quite so sharply in the next six months. In the Old Economy, declining inventories already point to improving sales and profits. Overall U.S. inventories are now falling at a 4% annual rate. And since many companies have already taken big write-offs for their excess inventory, much of the bad news has already been accounted for. Hard-hit USX Corp. (X ), the parent of U.S. Steel Group, posted a loss of $30 million, vs. a $56 million profit a year earlier. But based on signs of stronger order volume, "demand and pricing appear to have bottomed out in the 2001 second quarter," says Chairman Thomas J. Usher. And 3M saw profits drop 57% in the second quarter, to $202 million. CFO Robert J. Burgstahler says his company has whittled down inventories and has seen clients do the same. "Our customers are running pretty lean and close to the bone," he says.

SEEDS OF CHANGE. The only thing protecting Corporate America from a complete debacle is consumers, who continue to spend. The just-arriving tax refunds should sustain the trend. Ken Matheny, senior economist at Macroeconomic Advisors in St. Louis, figures the refunds will boost gross domestic product by about 1% over the next year. Some big consumer-product companies are doing just fine: PepsiCo Inc. (PEP ), for instance, saw quarterly profits jump 16%, to $652 million, as it introduced Code Red, a hot-selling cherry-flavored version of Mountain Dew. "In the kind of categories we compete in, innovation always drives sales," says PepsiCo CEO Steven S. Reinemund.

When profits do rebound, no one expects a breakneck recovery. Thomson Financial/Carson projects that earnings per share for Standard & Poor's 500 companies in the third quarter will decline 12.1% year-to-year. In the fourth quarter, it expects only a scant 0.4% rise. A continued decline in energy costs will help some sectors. Airlines are hoping for a rebound next year after a mostly dismal second quarter in which transportation-sector profits plunged 85%. Overall, U.S. carriers are forecast to lose $1.5 billion in 2001, the first industrywide loss since 1994. "When corporate profitability returns, we'll see an upturn in travel revenues," says Rono J. Dutta, president of UAL Corp. "But the reality is that it's going to be a weak economy for some time." The parent of United Airlines Inc. posted a $291 million quarterly loss, not counting a possible $100 million charge for its aborted takeover of US Airways Group Inc.

It's hard to see much good news this quarter. But the seeds of recovery are there. Although inventories remain historically high, by yearend most companies should have shed the mountain of excess computers and other goods that are hobbling corporate profits. For investors and anxious executives, it won't happen a moment too soon.

By Charles Haddad in Atlanta, with bureau reports

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