Earnings Rebound Will Take Patience

If the economy is indeed recovering, can a rebound in corporate earnings be far behind?

The stock market, still near its all-time high, is telling you that better profits are in the bag. And Wall Street analysts mostly agree. They estimate that earnings of the nation's largest companies will rise between 25% and 60% this year over last year's recessionary levels.

But the record-high corporate results that much of Wall Street foresees in 1992 probably are overblown, some experts warn. Better to tone down expectations.

The numbers matter to more than just stock owners. A recovery in earnings is essential if businesses are to expand again by hiring new workers and buying new equipment, which in turn would put people at other companies to work.

There is clearly encouraging news out there. Take Weyerhaeuser Co., the lumber and paper giant based in Tacoma, Wash. On Monday, analyst George Adler at brokerage Smith Barney, Harris Upham & Co. raised his first-quarter earnings estimate for Weyerhaeuser to 40 cents a share from 27 cents.

A surge in new-home building is boosting demand for lumber, which has lifted wood prices 25% or more since late in 1991. Demand has also improved for other Weyerhaeuser products, such as corrugated cardboard used in boxes--a sign that businesses are shipping more goods.

Weyerhaeuser, like most companies, doesn't specifically say what it expects to earn in a particular quarter. But Peggy O'Farrell, the firm's director of financial communications, says the company "has confidence" in Adler's forecasting abilities.

If Weyerhaeuser does report earnings of 40 cents a share in this quarter (ending March 31), that will be a 54% rise from the depressed 26 cents a share it earned in the first quarter of 1991. Multiply that experience times the thousands of companies that have suffered in the recession, and you can see how analysts arrive at their glowing profit expectations for 1992.

But some Wall Streeters argue that investors are making a mistake if they expect many other companies to duplicate Weyerhaeuser's rebound in the current quarter--despite the upbeat economic signals of the last two months. These doubters say any profit recovery is going to unfold at a tortoise's pace this year, and they worry that many investors won't be patient enough to hang on.

William Dodge, investment strategist at Dean Witter Reynolds in New York, says first-quarter earnings will be up sharply from last year only in "pockets"--for example, in the housing industry, where demand has come back strong.

Beyond that, Dodge sees many companies reporting still-lackluster results that mirror a slowly healing economy. His concern is that investors--now bombarded with daily news reports about the recession's end--will be unpleasantly surprised when first-quarter earnings reports begin to roll out in April, and the numbers look weak.

So Dodge recently told clients to cut back on stock holdings, anticipating a mild selloff in the next few months. At the start of the year, Dodge had advised clients to hold 65% of their portfolios in stocks, the rest in money funds and bonds. Now, that stock share is 55%.

What may puzzle investors is this: As American companies slashed costs, laid off workers and cut spending in recent years, there seemed to be an implicit belief that the result would be dramatically higher profits--just as soon as sales picked up even a small amount.

Now, many companies are getting that sales upturn, however slight. But the fantastic earnings leverage isn't there--at least not yet.

What happened? Thomas Doerflinger, who tracks corporate earnings trends for brokerage PaineWebber in New York, says the problem is akin to that old saying about trying to make ends meet when somebody keeps moving the ends.

Despite the corporate restructuring binge that began in the early 1980s, Doerflinger notes that profit margins of major American industrial firms rose only briefly later in that decade.

In the fourth quarter of 1980, for example, the average industrial giant earned a net profit margin of 4.79%--that is, 4.79 cents in profits for every $1 in sales. By 1988, the peak profit year for American companies, that profit margin had improved to just 5.4%. And last fall, as the recession dragged on, the net margin had plummeted to 3.18%.

Those numbers simply reflect the growing intensity of competition in business, both domestically and abroad, Doerflinger says. It's very hard for a company to raise prices anymore, and more typically prices are going down, he says.

So while U.S. firms may have once figured that their 1980s restructuring campaigns would produce sharply higher profit margins, the reality is that "most companies have had to cut costs just to maintain their margins," Doerflinger says.

Riverside-based Fleetwood Enterprises, which makes recreational vehicles, is a case in point. Paul Bingham, the company's finance chief, says sales are recovering nicely this year, up about 20% from a year ago. But extreme competition means "our margins aren't what they used to be," even with better demand, Bingham says.

To produce the earnings Wall Street expects, "we may have to reduce our cost structure" further, he says.

Likewise, stronger lumber prices may help Weyerhaeuser buck the trend for now, but that won't last forever--which is why, despite its improving results, Weyerhaeuser says its latest restructuring plan is only 50% completed.

The moral is that a sustained profit rebound for American business is going to be slow in coming and that the competitive battle will only get tougher along the way. If investors are planning on anything else soon, they'll be sorely disappointed.

Signs of Recovery...

The government reported new signs that the economy is climbing out of recession: Industrial production rose in February, as did housing starts.

Industrial Production Seasonally adjusted index, 1987 = 100 Feb.: 107.2 Source: Federal Reserve Board

Housing Starts Seasonally adjusted annual rate, millions of units 1992: 1.30 Source: U.S. Dept. of Commerce

. . but Will Corporate Profits Follow? American companies' profits have been falling since 1988, hurt by a slowing economy and huge writeoffs for plant closings and staff cutbacks. This year, an economic recovery is expected to boost profits. But some experts say 1992 estimates are widly optimistic.

Earnings for companies in the Standard & Poor's 500-stock index (expressed as a per-share figure) 1978: $12.33 1979: 14.86 1980: 14.82 1981: 15.36 1982: 12.64 1983: 14.03 1984: 16.64 1985: 14.61 1986: 14.48 1987: 17.50 1988: 23.75 1989: 22.87 1990: 21.34 1991: 15.83 1992: (estimate) 25.64 Source: Standard & Poor's Corp. (including 1992 estimate)

Profit Margins: Under Heavy Pressure

Despite all the cost-cutting and restructuring of the 1980s, corporate profit margins strengthened for only a brief period, in 1988-89. Many experts predict a slow climb from last year's depressed levels because of intense competition.

Earnings as a percentage of sales for 400 major industrial companies; fourth-quarter figures each year, except latest: 1980: 4.79% 1988: 5.40% 1991: 3.18% (Third quarter, latest available)

All figures based on results for Standard & Poor's 400 stock index.

Source: PaineWebber

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