Oil Is Expected to Stain Many 1st-Quarter Earnings Reports

For a wide range of companies, sky-high energy prices are bringing profits back down to earth.

With first-quarter profit reports rolling out in earnest this week, analysts predict that the results overall will show gains compared with a year earlier. But profit growth is slowing at many companies in part because of crude oil and gasoline prices.

At the end of the first quarter, oil prices were 55% higher than at the end of the first quarter of 2004. Companies have seen their operating costs rise, or their sales fall as customers have been forced to spend more on fuel, or both.

Aluminum giant Alcoa Inc., for instance, reported a 27% drop in first-quarter profit, in part because of high energy costs. Automakers General Motors Corp. and Ford Motor Co. have warned that their first-quarter results suffered as buyers shied away from gas-guzzling sport utility vehicles and trucks. And most airlines got hammered by jet fuel costs that soared more than 50% over the last year.

Consumers, perhaps the key engine powering the growth of corporate earnings and the economy, are paring their spending in the face of stiff fuel bills. A disappointing 0.3% rise in retail sales last month was blamed partly on high gas prices. Some discount retailers, such as Wal-Mart Stores Inc., have voiced concerns that the prices could pinch their growth as shoppers -- many on low-income budgets -- must spend more at the pump.

“We can’t quantify it yet, but clearly the high fuel prices are making things more difficult for our customers, especially those who live paycheck to paycheck,” Wal-Mart spokesman Marty Heires said.

Buying products and services one doesn’t need -- what experts call discretionary spending -- “is the kind of decision that gets postponed by high gas prices,” and that can quickly become a drag on earnings growth, said Gail Fosler, chief economist at the Conference Board, a business-supported research group in New York.

Oil prices hit a record closing high of $57.27 a barrel April 1. They have retreated in recent days but staged a rally Thursday, gaining 91 cents to $51.13 in New York trading. Gasoline prices also have spent several weeks in record territory.

First-quarter operating earnings for all the companies in the Standard & Poor’s 500 index are expected to rise an average 8.4% from a year earlier, according to Thomson First Call, which surveys analysts’ forecasts. That would be down sharply from the 20% growth rate posted in last year’s fourth quarter and the 27.5% surge in the first quarter of 2004.

The news isn’t all bad: High energy prices continue to benefit the oil industry, which is expecting big first-quarter gains. For example, Westwood-based Occidental Petroleum Corp. is forecast to report a 59% surge in first-quarter earnings compared with a year earlier.

But if the oil companies are excluded, the S&P; 500’s first-quarter profit growth is expected to drop to 5.2% -- just one-fifth of the gain seen in last year’s fourth quarter.

That’s a glass half-empty in Wall Street’s view. Earnings disappointments and concerns that the economy might be going sour helped knock 229 points, or 2.2%, off the Dow Jones industrial average over the last two days, pushing the blue-chip gauge to a five-month low.

Some analysts contend that high energy prices aren’t the main reason for the slowdown in first-quarter earnings growth, noting that the results pale when compared with last year’s pace.

“We’re coming off a string of six straight quarters of fairly strong growth,” said John Butters, Thomson First Call’s senior research analyst. “It’s hard to continue that string.”

But in some industries, high fuel costs are delivering a direct hit to the bottom line.

Airlines such as Delta Air Lines Inc. and UAL Corp.’s United Airlines, already in deep trouble, are expected to show massive first-quarter losses in good part because of surging fuel prices. The 10 largest U.S. carriers combined are forecast to report a $2-billion quarterly loss.

Low-cost carrier Southwest Airlines Co. on Thursday bucked the trend by reporting first-quarter profit that nearly tripled from a year earlier. A key reason: More than 80% of Southwest’s fuel bill was locked in at relatively low prices by the carrier’s use of hedging techniques.

In the auto sector, not only did GM and Ford slash their first-quarter guidance, German automaker BMW also has said its earnings this year might not match 2004 levels because high oil prices have raised the cost of plastics and other materials used in its luxury cars.

Many cargo shippers, railroads and trucking firms have been able to pass along fuel surcharges to customers, and the shippers’ earnings and sales have remained robust thanks to the economy’s expansion. But even they are warning that the fuel costs are starting to hurt.

FedEx Corp. last month posted a 53% jump in fiscal third-quarter profit, yet the delivery giant’s chairman, Frederick Smith, warned analysts that “the recent surge in energy cost is becoming a concern.”

Costco Wholesale Corp. is one retailer that says it hasn’t yet felt the effect of higher gas prices.

“Logically, it should be a negative, but we haven’t seen it,” said Richard Galanti, Costco’s chief financial officer.

In fact, Costco and other big-box discounters are selling increasing amounts of gasoline themselves. And their discounted pump prices often get media attention when gas prices surge, which tends to bring in new customers, Galanti said.

Costco’s fiscal third-quarter earnings, due to be reported next month, are expected to climb 10% from a year earlier, according to analysts surveyed by Thomson First Call.

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Slower growth

Year-over-year profit growth is expected to slow for most sectors of the S&P; 500 in the first quarter.

*--* S&P; sector Q1 ’04 Q1 ‘05* *--*

*--* Materials** +109% +52% Energy +18 +39 Industrials +29 +13 Technology +68 +13 Consumer staples*** +13 +6 Healthcare +14 +6 Telecom -13 +6 Utilities +2 +4 Financial +32 +1 Consumer +41 -12 discretionary**** *--*

*--* S&P; 500 +28 +8 *--*

*Estimates **Includes steel, mining, paper. ***Includes food, household products. ****Includes autos, restaurants.

Source: Thomson Financial