Profits: There's Bad News, and There's...Bad News
The forecast called for recovery in the fall. Then came September 11. Now the corporate damage assessment is in: Third-quarter earnings for the 900 companies on BusinessWeek's Corporate Scoreboard plunged a breathtaking 55% from a year earlier. That was the worst drop in the 25 years of BusinessWeek's quarterly Scoreboards, eclipsing the second quarter's 52% decline. Margins were sliced by more than half, to 3% from the 6.8% return enjoyed by the group a year earlier. All this in a quarter in which revenues were surprisingly flat--up 1% in the third quarter from a year earlier.
And if you think this marks the bottom, brace yourself. Charles L. Hill, director of research at First Call/Thomson Financial, estimates that earnings for companies in the narrower Standard & Poor's 500-stock index, which dropped an estimated 20% in the third quarter, will decline another 20% in the fourth, when the full economic brunt of the September 11 tragedy hits. What's more, Hill thinks the downward trend could stretch as far as next year's third quarter: "Investors need to put on their hard hats, because they're going to be bombarded with earnings warnings over the next several months."
Indeed, while some economists believe the economy could stabilize as soon as the spring, as rate cuts--including the Federal Reserve's half-point reduction on Nov. 6--and congressional tax cuts kick in, Wall Street forecasters say the turnaround in profits could take longer. The reason: Many service-sector companies that were betting the economy would rebound by now are finally biting the bullet and paring back. That means more layoffs, more restructurings--and more of the special charges that eat into profits. As a result, it might be years before companies match their record earnings of last year. "You can't jump back to 2000-level earnings unless growth snaps back to 5% to 6%, and that isn't likely to happen for quite a while," says Salomon Smith Barney Inc. economist Steven Wieting.
DEFENSE PROFITS. The third quarter--marked by a 0.4% fall in gross domestic product--was so bleak that success became relative. General Electric Co. (GE ) claimed honors as the earnings champ with a mere 3% rise in profits, to $3.28 billion. Meanwhile, the second-quarter leader, Exxon Mobil Corp. (XOM ), saw its earnings plunge 29%, to $3.18 billion, with the collapse in oil prices. What does GE have that Exxon doesn't? Diversification. Despite suffering $400 million in insurance losses related to the terrorist attacks--its Employers Reinsurance unit covered part of the World Trade Center and at least some of the lost airplanes--GE says it managed to keep profits up with continued growth in its power-systems, medical-systems, and financial-services units. "At times like this, the diversity of our portfolio really matters," says Chairman and Chief Executive Jeffrey R. Immelt.
But GE was an exception. Barely 400 companies in BusinessWeek's survey turned in higher profits, while nearly 500 either lost money or saw earnings drop. Of the 66 industry sectors tracked by BusinessWeek (MHP ), only 15 had higher profits than a year ago. Among them were defense contractors, the construction industry, and four health-care sectors. Drugmakers, for example, enjoyed a collective 10% rise in earnings on an 11% jump in sales. The strongest gains there came from Pfizer Inc. (PFE ), whose profits rose 52%, to $2.07 billion, on the strength of its cholesterol-lowering drug, Lipitor. And Stephen M. Scala, an analyst at SG Cowen, expects the big drugmakers that he follows to boost earnings by 13% in 2002.
The tech and telecom sectors, which began losing altitude last year, remained the biggest drag on profits. Chipmakers, stung by slowing demand for PCs and a bitter price war between Intel (INTC ) and Advanced Micro Devices (AMD ), lost $7.2 billion, while Motorola (MOT ), Avaya (AV ), and other electronics makers were collectively $1.9 billion in the red. The biggest loser among the 900 Scoreboard companies was Lucent Technologies (LUC ), which posted an outsized loss of $7.33 billion--reflecting write-offs and one-time charges--and a 28% drop in revenues, to $5.16 billion, as demand for telecommunications equipment continued to wither.
The pain in the telecom sector is now spreading to the Bell operating companies. While their local monopolies traditionally insulated them from recession, the Bells are feeling the pinch from the decline in the Internet sector. The number of local-access lines has slipped 1.3% industrywide since the third quarter of 2000, and growth in such services as high-speed Net access and network management that were supposed to pick up the slack is slowing sharply. BellSouth's (BLS ) earnings were wiped out by a $1 billion write-off of its 3% stake in data-carrier Qwest Communications International (Q ), while SBC Communications' (SBC ) profits dropped 31%, to $2.07 billion.
Few industries, though, are suffering more than the airlines. They were hit with rising labor costs and slowing traffic even before the terrorist hijackings, and many analysts now expect a brutal shakeout marked by bankruptcies and mergers. UAL Corp. (UAL ), the parent of United Airlines, lost a record $1.16 billion in the third quarter. Likewise, at Delta Air Lines Inc. (DAL ), which lost $259 million, "recovery is not visible at this point," warns President Frederick Reid.
If there's a glimmer of good news, it's that some industries that were devastated in the last recession appear better positioned this time. Salomon's Wieting notes that despite rising loan losses, the banking sector has held up well. Meanwhile, many heavy manufacturers began slashing costs more than a year ago, sharply lowering their break-even points. True, U.S. auto makers, which historically lose billions during recessions, are struggling: DaimlerChrysler (DCX ) and Ford Motor Co. (F ) are both headed for full-year losses. But General Motors Corp. says aggressive cost-cutting will keep it profitable in the fourth quarter--and even in 2002, when U.S. auto sales are projected to drop 7%. "We won't generate a lot of cash, but we'll hold our own," vows GM Chief Financial Officer John M. Devine. He still expects GM (GM ) to earn $275 million in the fourth quarter, vs. $89 million a year ago. As the recession deepens, just remaining profitable in coming quarters may be a feat in itself.
By Dean Foust and Aixa M. Pascual in Atlanta, with bureau reports