The Sales Engine Kicks In
In 2003, companies saw the results of productivity improvements flow to the bottom line. Now the final piece of the corporate-profit recovery is falling into place: sales growth. First-quarter earnings for the 900 companies in BusinessWeek's Corporate Scoreboard surged 25% from the year before. But what stood out even more was the Scoreboard's 12% increase in revenue, the largest gain in three years.
That's good news because companies can't drive profits through cost-cutting forever. Sales must rise if earnings gains are to be sustained. "Now what you have is the top line growing fast, and cost restraint remaining tight," says Richard Rippe, chief economist for the Prudential Equity Group (PRU ). "That's nearly perfect for profits." Indeed, rising revenues helped plump up margins this quarter to 7.5%, from 6.7% the previous year.
First-quarter earnings came in above expectations, with especially strong results at big Wall Street investment banks, the tech sector, and machinery makers. And if not for a dip in net income at ExxonMobil Corp. (XOM ), total Scoreboard profits would have been two percentage points higher. Because of a tough comparison with its 2003 first quarter, which was inflated by a one-time gain of $1.7 billion from the sale of its stake in German pipeline company Ruhrgas, the oil giant had a 16% decrease in first-quarter earnings, to $5.4 billion. That was still good enough to make ExxonMobil the Scoreboard's biggest single profit contributor.
Going into the quarter, analysts had said forecast earnings would advance 13.4%, according to a consensus estimate by Thomson First Call (TOC ). First Call's numbers are based on analysts' estimates and exclude certain unusual items. (Scoreboard profits are based on reported income from continuing operations before extraordinary items, as defined by generally accepted accounting principles. That earnings definition includes such things as asset sales and charges for layoffs.) But that forecast has ratcheted up in the last month, even including recent laggards such as the airlines and the drugmakers. "Analysts clearly underestimated the strength of first-quarter earnings," says First Call's Kennard Perkins.
The revenue acceleration that powered profit gains was widespread. Sales growth improved in 58 of the 60 Scoreboard industries. Higher sales were undoubtedly a reflection of a strong economy. In the first quarter, gross domestic product expanded at a 4.2% annual rate, according to the advance estimate. Sales gains were especially notable in such areas as capital goods, the wireless-phone business, and semiconductors. The 12% sales advance comes on the heels of a 10% rise in the last quarter of 2003, for the first back-to-back quarters of double-digit growth in three years.
PRICING POWER. Companies now are also finding it easier to do something they haven't been able to do much of in years -- raise prices. Thanks to revved-up international demand, Dow Chemical Co. (DOW ) had a stellar first quarter. Sales rose 15% to a record $9.3 billion, as overall price hikes of 8% and 7% higher sales volume combined to offset rising costs of energy and feedstock. Dow continues to exercise pricing power in the second quarter -- for instance, the company on May 1 raised the price of solvents by 5%. "We are on the way to a much better supply-demand balance," says Dow Chief Financial Officer J. Pedro Reinhard. The result: The largest U.S. chemical manufacturer finished the quarter with margins of 5% and earnings of $469 million, a fivefold year-to-year rise.
David A. Wyss, chief economist at Standard & Poor's (MHP ), said pricing power should continue to buoy profits through 2004. Of course, those price increases are already leading to rising interest rates, and some economists expect the Federal Reserve Board to join in with a June hike. But most companies have shored up their balance sheets, locking in lower rates on debt, according to Wyss. That, plus the delayed effect rates have on the economy, means "I don't see it affecting earnings until the second half of next year," he says.
While consumers carried the economy through the recession, execs are now taking the lead in generating growth. More managers are feeling confident that the recovery will last and are boosting their budgets accordingly.
Five of the 10 industries that had the most impact in lifting first-quarter Scoreboard profits were capital goods companies. And preliminary government figures for the first quarter, released on Apr. 19, show business spending on equipment is the economy's fastest-growing major sector. "The last several years have been a cash-conservation mode," says James V. Gelly, CFO of Rockwell Automation Inc., a maker of industrial equipment. "Today, people are having to part with the buck. And end users are feeling secure enough to make those investments."
The recovery is reaching nearly every corner of techville and most telecom companies. It's not surprising then that chips, the product that is at the heart of most gadgets, added the most to Scoreboard profits. The chip industry climbed back from a year-earlier loss, stoked by demand for semiconductors for PCs, servers, and wireless notebooks, as well as new uses such as high-end cell phones. Bellwether Intel Corp.'s (INTC ) profits rose 89%, to $1.7 billion, on a 20% increase in sales. Apple Computer Inc.'s (AAPL ) profits climbed 229%, to $46 million, on a 29% jump in sales, to $1.9 billion, driven by the runaway success of its iPod digital music player. But this tide isn't lifting all boats: Sun Microsystems Inc. (SUNW ), for example, posted a $760 million loss on a 5% sales slump, as its high-end servers continue to be undercut by lower-priced machines.
Most of the U.S. wireless industry surged in the first quarter as new subscribers soared. Even once-beleaguered Motorola Inc. (MOT ) boosted earnings by 260%, to $609 million, on a 42% rise in revenues, largely a result of cell-phone sales. At Cisco Systems Inc. (CSCO ), the giant network-equipment marketer, sales rose 15%, driving a 30% improvement in profits to $1.3 billion.
Microsoft Corp. (MSFT ) takes the blame for the 15% decline in software-sector profits. Big charges for antitrust litigation -- which are included under our definition of earnings -- drove down income at the software giant by 39%, to $1.3 billion. But cross out those one-time charges, and Microsoft's profits beat analysts' forecasts. So did sales, which jumped 17% to $9.2 billion, reflecting the surge in corporate IT spending.
The recovery isn't limited to tech companies by any stretch. Diesel engine sales at Cummins Inc (CMI ). climbed 28%, leading to a $33 million profit compared with a $31 million loss the previous year. Steel producers are running flat-out to meet demand. Long-stressed United States Steel Corp. (X ) posted a 53% surge in sales and replaced a first-quarter 2003 loss of $33 million with a $44 million gain this year. "We're looking for great numbers in the second quarter," says CEO Thomas J. Usher.
With the economy humming along, the stock market has followed suit. Big investment houses such as Lehman Brothers (LEH ), Bear Stearns (BSC ), Goldman Sachs (GS ), and Merrill Lynch (MER ) all posted blowout first quarters. Lehman captured the largest gain of that bunch, with a 123% increase in profit, to $670 million. Commercial banks benefited from strong consumer business. Citigroup (C ), the Scoreboard's second-biggest profit contributor, also reported the second-largest absolute earnings gain. Its earnings advanced 29%, to $5.3 billion.
Indeed, consumers have hardly climbed into a hole. Many retail companies benefited from improved sales as well as cost reductions. Higher-end chains reported the biggest advances, thanks to the wealth effect of a resurging stock market. First-quarter profits at luxury retailer Neiman-Marcus Group Inc. and handbag maker and retailer Coach Inc. both (COH )jumped by more than 80%. At the other end of the consumer spectrum, McDonald's Corp.'s (MCD ) net income surged 40% to $511.5 million as same-store sales leaped more than at any time in almost two decades. "We are confident the U.S. will have another good year in 2004," says Charles Bell, the fast-food giant's new chief executive.
Airline revenue also rebounded, but that wasn't enough to bring the mainline carriers back into the black. Revenue at four of the largest airlines -- American parent AMR (AMR ), Delta (DAL ), Continental (CAL ), and Northwest (NWAC ) -- rose 8% to $12.7 billion. Collectively, however, the four lost $896 million on unexpectedly higher fuel costs.
Still, with business spending on the rise and consumers continuing to open their pocketbooks, the profit picture going forward looks good. Earnings growth for the second half may be less spectacular. The latter part of 2003, after all, saw productivity improvements give earnings a strong lift, so those comparisons will be tough to beat. But as long as sales keep rising, it's hard to see how strong profits won't keep rolling in.
By Robert Berner, with Michael Arndt, in Chicago and bureau reports