U.S. Margins Stagnate for Longest Stretch in Three Years
Chief executive officers in America are finding fewer costs to cut, sending profit margins into the first 12-month contraction since 2009 and leaving investors increasingly dependent on economic growth to boost stocks.
Standard & Poor’s 500 Index companies earned $81.93 a share in the last 12 months on sales of $919.39 a share, generating margins of 8.9 percent, according to data compiled by Bloomberg that excludes banks. The measure, a key gauge for investors, slipped from 9.0 percent, the first decline after a three-year, 1.6 percentage point expansion, the biggest ever.
Bears say the contraction shows executives have squeezed all they can from expenses and point out that stagnant profitability accompanied recessions in 2000 and 2007. Bulls say housing and employment data show the American economy is picking up speed and that even if earnings contract, valuations are so low that share prices will build on the 109 percent rally since March 2009.
“Margins collapse when economies are weakening, which is the last thing you want to see,” said Russ Koesterich, the San Francisco-based global chief investment strategist for the IShares unit of BlackRock Inc., on Oct. 24. His firm oversees $3.67 trillion. “That companies remain very profitable has helped support stock prices. If that starts to diminish, it will obviously take away a little bit of the luster.”
The S&P 500 fell 1.5 percent to 1,411.94 last week as companies from Caterpillar Inc. to DuPont Co. said a slowdown in sales will curb earnings growth and analysts cut their margin forecasts. The benchmark gauge for American equities has decreased 3.7 percent since reaching a five-year high on Sept. 14, trimming its 2012 advance to 12 percent. That’s about twice the average annual gain since 1900, according to data compiled by Credit Suisse Group AG in Zurich.
The U.S. securities industry canceled equity trading on all markets today, moving to protect workers as Hurricane Sandy barreled toward New York City with 70-mile-per-hour winds and the threat of an 11-foot sea surge. Futures on the S&P 500 dropped 0.5 percent at 4:31 a.m. in New York. Trading will stop at 9:15 a.m. because of the storm, CME Group Inc. said.
Allegheny Technologies Inc. (ATI) plunged 11 percent on Oct. 24 after the maker of specialty metals for aerospace and energy markets reduced its 2012 forecast and said margins narrowed. Earnings before interest, taxes, depreciation and amortization at the Pittsburgh-based company fell to 9.8 percent of sales last quarter, from 12.3 percent a year earlier, Bloomberg data show.
Three years of economic growth pushed S&P 500 earnings to a record, underpinning a rally that has added $8 trillion to equity values over 44 months. Margins expanded as profits climbed 52 percent from 2009 through the 12 months ended in October, compared with a 26 percent rise in sales, data compiled by Bloomberg show. For the last year, sales and earnings rose by about the same amount, 5 percent, ending the gain in margins.
Profit margins in the S&P 500 (SPX) excluding financial firms have averaged about 6 percent since 1993, according to Bloomberg data. They rose 49 percent above that level to a record last October as companies cut employees and took advantage of falling interest rates, according to data compiled by Bloomberg. The average length of margin contractions since 1993 has been 16 months, the data show.
“The first half of next year is going to be a bit of a struggle,” said David Joy, the Boston-based chief market strategist at Ameriprise Financial Inc., which oversees $678 billion. He spoke in an Oct. 23 phone interview. “This is a difficult time for corporate leadership to try and figure out: what can we do to maintain the type of earning growth that we’ve enjoyed? Unless something else happens, they won’t be able to.”
Slipping margins have contributed to lower forecasts for profitability. Analysts say third-quarter income for S&P 500 companies probably rose 1.8 percent, down from an estimate of 9.3 percent at the start of the year. Predictions for the current period have fallen by 10 percentage points since April.
Even if margins fail to rebound, shares are so cheap relative to profits that they could keep rising, said Brian Jacobsen, who helps oversee $208 billion as chief strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, in an Oct. 23 phone interview. S&P 500 companies are trading for 14.3 times earnings, more than 10 percent below the five-decade average of 16.4, according to data compiled by Bloomberg.
Earnings for all U.S. companies with a market value of more than $1 billion will probably advance to about $1.13 trillion in 2012, according to data and analyst estimates compiled by Bloomberg. That compares with $784 billion in 2007.
“It seems like people are anticipating that profitability has got to break down,” Jacobsen said. “Even if we have flat earnings or even declining earnings, we could see sentiment begin to improve, in which case that could lead to multiple expansion and continue to drive the market higher.”
Estimates for earnings growth next year have held up even as they have declined for U.S. economic growth. Gross domestic product will expand by 2 percent in 2013, down from a prediction of 3 percent in July 2011, according to the median estimate of 89 economists surveyed by Bloomberg. S&P 500 profits will increase 10 percent next year, unchanged from the expectation 1 1/2 years ago, more than 9,000 analyst estimates compiled by Bloomberg show.
GDP, the value of all goods and services produced, rose at a 2 percent annual rate in the third quarter after climbing 1.3 percent in the prior period, Commerce Department figures showed Oct. 26. The median forecast of 86 economists surveyed by Bloomberg called for a 1.8 percent gain.
Reports for last month showed the expansion is continuing in the fourth quarter. U.S. manufacturing unexpectedly expanded in September after three months of contraction and service industries grew by the most in six months, data from the Institute for Supply Management showed this month. Unemployment dropped to 7.8 percent in September, the lowest since 2008.
Koesterich said stocks may be spared losses once the presidential race between Barack Obama and Mitt Romney is decided and Congress finds a way to avoid the so-called fiscal cliff of tax increases and spending cuts set for January.
For the 273 companies in the S&P 500 that have reported quarterly results, earnings have declined by 0.4 percent. The rate of growth is the smallest since the third quarter of 2009, data compiled by Bloomberg show. Profit margins have averaged 10.3 percent, excluding banks.
Caterpillar, the Peoria, Illinois-based maker of farm equipment, posted the highest profit margin since at least 1980 last quarter at 9.2 percent. The company lowered its 2012 income estimate on Oct. 22 and said sales growth will be slower than in the previous three years as the global economy decelerates.
Joel Tiss, an analyst at BMO capital Markets in New York, estimated Caterpillar (CAT)’s net income margin will fall to 8.2 percent from 9.4 percent in 2012, with profits shrinking 12 percent, according to an Oct. 22 note to clients.
DuPont’s (DD) net profit margin may fall to 8.8 percent in 2012 from 9.6 percent last year, according to UBS AG. The Wilmington, Delaware-based chemical maker tumbled 9.1 percent on Oct. 23 after posting a smaller-than-estimated profit and cutting its forecast on declining demand for paint pigment and solar cells.
The share of earnings before interest, taxes, depreciation and amortization as a percentage revenue at DuPont climbed last year to the highest since 2002, according to Bloomberg data.
Profitability bottomed at 4.44 percent in March 2002 and staged a six-year recovery that peaked to 8.73 percent in October 2008 as the S&P 500 almost doubled. The financial crisis pushed margins down to 7.41 percent by December 2009 prompting companies to eliminate jobs, hoard cash and sell assets, Bloomberg data show.
“Global growth is just pretty slow right now,” said David Kelly, the New York-based chief market strategist at JPMorgan Funds, which oversees $348 billion. He spoke in an Oct. 23 phone interview. “From that, you can predict that earnings will do pretty poorly at this stage of the cycle.”
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