Cost cuts produce strong 3rd-quarter profits at many a company
It's turning out to be a record third quarter for some companies. Pushed by a strong recovery, corporate profits are piling up. Not all third-quarter reports are in yet, but no matter which estimate you look at, the message is the same: The cost-cutting during the recession is paying off in the form of strong earnings. And, as economists have been saying, the consumer-oriented companies are leading the way.
Cheers over earnings performance rose from Detroit last week when the Big Three automakers reported combined aftertax profits of $1.17 billion - a third-quarter record.
But the auto industry isn't the only star. ''A few other sectors have benefited recently,'' says Joseph Carson, senior economist at Merrill Lynch. ''Major gains have been posted by paper and forest, chemical, and drug companies ,'' he notes. Retail businesses, transportation companies, and building materials producers have also checked in with healthy gains.
Simple economics is at work here. During the past two years of fierce recession, companies have been forced to hack away at costs, closing marginal plants and resorting to widespread layoffs. As a result, productivity improved significantly. Not only that, but energy costs and prices for materials have been under control, too, and these factors have also helped the ''cost'' side of business.
With the recovery came welcome increases in demand for consumer products such as automobiles, appliances, and houses. Factories started turning out more of these products and, because of their productivity improvements, hauled in larger profits.
''The strength of the recovery is in volume,'' says Roger Brinner, an economist at Data Resources Inc. (DRI), an economic research firm in Lexington, Mass. ''That allows a profit gain for all the usual arguments. There's a lot of fixed costs, so there's nice (profit) movement with the economy still growing strongly.'' Mr. Brinner estimates that overall, third-quarter profits are up 46 percent from the same quarter last year. A Wall Street Journal survey shows profits up by 29 percent, and Industry Week magazine economics editor Dale Sommer sees a 25 percent increase.
But many industries are still down in the dumps. ''You are hard pressed to get the feeling of a booming economy in a lot of companies,'' argues Fred Plemenos, also at DRI.
Sheldon Wesson, at the American Iron and Steel Institute, says third-quarter performance for steel companies will see ''a modest improvement. It looks like operating losses have been reduced a little.'' The profit picture for the third quarter at the oil companies looks ''bland,'' according to Nicholas Gal, senior financial adviser at the American Petroleum Institute. Machine tool orders are up, but haven't yet trickled down to the bottom line for this hard-hit industry.
These are industries that supply businesses. They can't get their share of the profits until businesses begin to expand. But right now businesses generally aren't investing in new buildings or machines, because there is still excess factory capacity waiting to be used.
Another problem for industries like steel and oil is that prices have been soft. So production increases haven't translated to good financial performance. ''Sheet (metal) products for autos is the only strong segment of the industry at the moment,'' explains Mr. Wesson. ''Yet (the industry) is complaining because we are unable to get prices back to anywhere near the list price.'' The industry maintains that this is because cheaper imports are flooding this market.
As the recovery continues, though, analysts see these basic industries coming along. ''The capital-goods intensive industries should start recording larger increases than the consumer goods companies in the first and second quarters'' next year, maintains Mr. Carson at Merrill Lynch. ''We are just starting to see some significant increases in capital-goods orders, and this will transfer to the bottom line very soon,'' he says. And the gap will tighten, because consumer goods sales will slow their pace. ''The retailers enjoyed a vintage year in 1983 . It will be hard to get two years like that back to back,'' says Alan Murray, an economist at Citibank.
Most economists are predicting another year of profit recovery in 1984. ''You will have a fundamental environment of rising demand - by consumers, by businesses, and even in exports,'' Mr. Murray says.
He is not worried about higher inflation choking profits, and neither is DRI's Brinner. More reasonable wage and energy costs will still allow business to make sizable profit gains, they say. Brinner predicts aftertax profits will be up by 20 percent next year, and Murray is looking at a before-tax profit rise of 16 percent. A good deal of this increase will take place in the first half of the year, they say, with recovery slowing down in the second half.
Is there anything in the works that could upset the apple cart? ''A reversal of the wage moderation of the last several years is the most serious concern,'' says Edgar Fiedler, a Conference Board economist. ''My guess is that it will come gradually, rather than rapidly. The other factor is whether productivity gains will peter out.''
Over the long run, investors find that stock prices rise in anticipation of higher profits.
But some stocks' prices, particularly high-technology stocks, jumped far ahead of profits and have come back down in recent months.
Gordon Yale, secretary-treasurer of the Janus Fund, a mutual fund, still sees ''value in the larger-capital blue-chip stocks.''