Well we seem to be running with a theme, the "BAD", in all its' many guises this time around. So we'll continue it as we shift to discussing our first love business performance. Which, at the end of the day, is all about earnings, which in turn is about growth and profitability. Contrary to the headlines even the companies that reported decent earnings this last time around also reduced their outlooks. And it's not just the Finance Industry either, whom we've been beating up right and left along with everybody else, and deservedly so. Or the Auto Industry, whom we'll get in due course. In this post we'd like to concentrate on Consumer and Industrial companies and after the break you'll find Categories on Earnings plus Consumer (TGT, MickeyD's, CostCo, SHLD, and Sony) and Industrial (UPRR, GE, UTX, Boeing, and CAT). None of whom were particularly sanguine though UPRR was perhaps the most optimistic of the lot, with the major rails having re-discovered pricing power. But even CAT flew a few small warning flags.
Profits and Earnings
Just to put it all in perspective let's borrow a couple of charts from Northern Trust's econ team. You need to take a careful think of this chart and maybe even click on thru to the NT review it comes from. What they have to say though is this, "Are we in a recession or are we not? The debate goes on. Take a look at the year-over-year change in operating profits of the S&P 500 corporations (see Chart 1). Profits have declined for three consecutive quarters through the first quarter of this year". Operating earnings back to '90 are about as bad as they've been and it turns out after-tax profits in the Tech Bust and now are the biggest hits going back to '65. Couple that with the last two econ outlook posts and we'd have to say there are still a bunch of wild-eyed optimists on Wall St. Just domestically we expect the pressures to continue to mount but for everybody looking for the foreign uplift - well if the world slows and currency conversions are no longer as favorable, what then ? The word that comes to mind is OUCH !
Elements of Performance: UTX and GE as Exemplars
Last year was the first in history where buybacks exceeded profits for the year and the pressures from the Street to continue that practice are on-going. In fact one story is about Bill Ackman's continuing investment plus pressure on Target to do just that. Judging from these charts and the outlook there couldn't be a worse time - unless of course you're strategic goal is to effectively liquidate the enterprise. Otherwise buybacks make sense only when the stock is significantly under-valued on a long-term strategic basis, instead of buying it in the face of further likely declines. (Market Drivers 3 (Buybacks):Investment, Hiring, Nah...Bonus, Bonus, Bonus !)
One of the companies who turned in an outstanding performance however is United Technologies (UTX) who also had a pretty positive outlook across their divisions and worldwide. Though clearly they're exposed to all the domestic and international pressures we've discussed and may either not be anticipating them, or downplaying them. Aside from good products, insightful marketing and positioning and a significant int'l presence across several different industries at the heart and soul of their performance is "operational excellence". Something we've harped on over and over again. Several years ago UTX found their performance lagging and instituted a major corporate renewal strategy designed to develop, deploy and implement an integrated "operating system". They've been demonstratively successful and, IOHO, could serve as the poster child for the kind of integrated enterprise management system that couples strategy with execution and functions to the overall enterprise. They call their approach ACE for Achieving Competitive Excellence and this composite tells you, reading clockwise from the upper left, what the strategic components are, shows an example of the kind operational detail involved, charts the current deployment status (telling us how far they've got to go and how much sustained effort is required to do this right) and what the impacts have been on measurable performance. A poster child, we're telling you.
On the other hand let's consider GE which continues to get beat up for lackluster stock performance. Largely on the grounds that it's too big, unwieldy and a conglomerate no one understands. One of the reasons we dug into UTX is that it's also a major multi-industry conglomerate who's managed to do pretty well, which should knock most of that particularly argument on it's head. That the analysts can't figure it out is sad given what they're paid to learn it. And we will admit, and have said, that hanging on to NBCU still doesn't make sense within a corporate framework of industrial + finance focus. We'll further admit that GE's failure to look ahead adequately at the economic trends got 'em into serious trouble quarter before last. Nonetheless their challenges have been a couple of orders more daunting than UTX's, and not just because of the size differences. For one thing Immelt inherited much too high a stock price and PE based on the bubble and Welsh effects. For another Jack left a lot of unraveling for Jeff to do in the first several years. Divisions that should have never been acquired or kept needed to be replaced with those more focused on key strategic trends. And GE has done a great job of completely re-vamping and re-positioning itself for those future trends as well as continuing to run tight ship. If you check out the accompanying chart you'll get a sense for what the strategic trends it sees are, how it's re-positioning and how it goes about executing. IOHO Immelt has positioned GE for the way the world's going to look for the next several decades and done so well with speed, force and style. On top of which people also need to understand that much of their financial activities are synergistic complements to the various vertical businesses. By combining a deep understanding of it's customer's business with it's own industry expertise with deep financing pockets it creates a unique competitive advantage.
So as you skim over the excerpts and contemplate your own situation and investment plans you might keep all these factors in mind. With reference to these models if you like (Performance Assessment Basics: Five Fundamental Factors,Masterclass: Buffett on Investing and Business Analysis).
Profits and Earnings
S&P 500 Corporate Profits Leave Little Recession Doubt Are we in a recession or are we not? The debate goes on. Take a look at the year-over-year change in operating profits of the S&P 500 corporations (see Chart 1). Profits have declined for three consecutive quarters through the first quarter of this year. Given reports of second-quarter profits to date and estimates of those corporate profits to be reported, it is a good bet that year-over-year profits will be down for four consecutive quarters. The data series in Chart 1 only goes back to the first quarter of 1989. But these limited data points suggest that the current behavior of corporate profits is signaling a recession. The data for year-over-year changes in reported S&P 500 profits (see Chart 2) start in the first quarter of 1965. The message is the same – current corporate profit behavior is consistent with past behavior in periods of recession.
Bear Market Rally May Fizzle as Profits Dry Up at Black & Decker, Novellus The predictions among Wall Street analysts that corporate earnings will be the catalyst for a bull market this year are losing credibility with the cascade of U.S. companies making bearish forecasts. Black & Decker Corp., the largest maker of power tools, cut its 2008 estimate July 25, citing a slump in U.S. homebuilding that is lasting longer than analysts expected. Kimberly-Clark Corp. failed to anticipate pulp and oil costs that were twice its original projection. Of the 63 Standard & Poor's 500 Index companies that provided outlooks this quarter, 30 said profits will fall, data compiled by Bloomberg show. The company announcements conflict with the advice investors are getting from Lehman Brothers Holdings Inc., JPMorgan Chase & Co. and UBS AG. The S&P 500 will rise 21 percent from its July 15 low to 1,473 this year, according to the average of nine strategists tracked by Bloomberg. While the index rose 3.5 percent since July 15, gains have proved short-lived 10 times during the four U.S. bear markets since 1973.
Analysts Overstate Earnings Once Again We have been noting that earnings expectations are way too high for the second half of the year (Q3 +20%, Q4, +50%). It turns out that they were also way too high for Q2:
"Halfway through earnings season, banks are still a drag, tech firms are doing OK while the overall outlook remains cloudy. With 249 of the S&P 500 companies reporting results, second-quarter profits are on track to decline 17.9% vs. a year earlier, according to Thomson Reuters."I'd rate (earnings so far) as pretty bad," said Sam Stovall, chief investment strategist at S&P Equity Research. S&P forecast a 10% drop at the start of the quarter but now sees about a 20% shortfall, he said."
Interestingly enough, the chart of earnings from IBD also includes a line for earnings ex-financials If they were trying to illuminate the earnings picture, they might have also shown earnings ex-energy. As Bloomberg noted earlier this quarter, "Take away Exxon Mobil Corp., Chevron Corp. and ConocoPhillips and profits at U.S. companies are the worst in at least a decade." One would think showing an ex-negative might be balanced by showing the ex-positive. (One would be wrong).And it is somewhat odd that I don't recall IBD showing SPX earnings in 2005-07 period ex-financials. If they were truly astute, they might have shown how artificially pumped up earnings were over that period. Had they done so, it would have revealed exactly how artificial those profits were, and could have saved their readers untold billions. No matter. Such is the money losing ways of the perennial cheerleaders. Read and watch them at your own financial risk .
Consumer
Ackman Adds Cash to Target Corp. Hedge Fund as Retailer's Stock Slides 38% William Ackman put more cash into the $2 billion hedge fund he started to invest in Target Corp. as shares of the second-largest U.S. discount retailer declined 38 percent in the past year, according to two people with knowledge of the matter. Pershing Square Capital Management LP, Ackman's New York- based firm, added at least $100 million to the fund, while he personally committed $5 million. Ackman also solicited money from current and new investors, said the people, who declined to be identified because the fund is private. Since he purchased Target shares, Ackman has pressured the retailer to buy back stock, generate cash from its real-estate holdings and sell its credit-card portfolio to increase the share price. Target closed 24 cents lower yesterday at $43.68 in New York trading. Target said in November it would repurchase $10 billion of shares by the end of 2008. The company also completed the $3.6 billion sale of 47 percent of its credit-card loans in May to New York-based JPMorgan Chase & Co., the biggest U.S. bank by market value. Pershing also suggested a real-estate transaction in May that would help the retailer extract cash from its holdings, a move that Ackman has told investors he expects will create the most value at the company.
McDonald's Flags Cost Pressures McDonald's quarterly results beat Wall Street expectations amid strong growth overseas, but the fast-food chain said the cost of beef and other inputs is a growing problem.
Inflation to Hit Costco's Profit Costco Wholesale Corp. Wednesday warned that its fiscal fourth-quarter and fiscal-year profits will be well below analysts' current estimates, as inflation, particularly from energy costs, clouds its outlook. Shares of Costco were down $7.86, or 11%, to $64.16 in morning trading on the Nasdaq Stock Market. The company said it will take a higher-than-expected inventories charge; profits at its gasoline operations will fall compared with last year; and merchandise profits will be lower because it has had to hold prices to help drive sales.
Sears: Finally, a Reason to Brag Recently, Sears (SHLD) no longer seems to be where America shops for much of anything. Sales skidded 9.8% in the latest quarter, leading to a $56 million loss as consumers shunned the dreary shopping experience for more focused low-price options such as Wal-Mart (WMT) and Target (TGT). With Chairman Edward S. Lampert warning that bad times could last into 2009—and the search for a CEO still under way—the stock has fallen by more than half in a year. The numbers are the worst since Lampert combined Kmart and Sears in 2005. But one part of the $50.7 billion company is sparkling: Lands' End (SHLD). The apparel subsidiary is thriving with its reputation for impeccable customer service and sturdy-but-stylish designs. While Sears doesn't break out numbers, retail analyst Anne Brouwer of Chicago's McMillan/Doolittle estimates the unit made $200 million on $2.2 billion in sales last year. The challenge is to keep the momentum going. On July 18, after barely three years as Lands' End chief, David W. McCreight left to become president of athletic-apparel maker Under Armour (UA). While McCreight, 45, generated record earnings growth at the unit, some feel he never adjusted to rural life at Lands' End Dodgeville (Wis.) headquarters. Hired as chief merchant in 2003, McCreight came up with the idea of stand-alone boutiques in Sears. As president, he freshened product lines and spurred innovation, including a new packing process. McCreight also moved a half-dozen customer service agents to a space right outside his corner office, so he could pull up a chair and participate in calls.
It Takes a Crisis For years Sony persuaded consumers to pay a premium for its gadgets by inventing them first--think Walkmans and camcorders. Today it loads them up with superior technology, which produces clearer TV pictures or tells digital cameras to shoot when the subject smiles. Stringer's goal is to connect its devices--televisions, music players, PlayStation machines--to one another and to a new Sony network for downloading movies, TV shows, games and other digital content. Downloading goes via the PlayStation 3 console, turning it into a home computer server that can handle movie rentals as well as play games. In addition, Sony's Bravia flat-screen TVs will allow viewers to connect to the Internet and stream Hollywood hits without a set-top box or cable subscription; already the TVs can do this with YouTube and other free Internet channels. But how could Stringer get his devices talking to each other in a company whose executives were barely talking to each other? When he took over, Sony was so dysfunctional--and divisions guarded their territory so fiercely--that managers working for one division wouldn't return phone calls from their counterparts in another division. Cheerleading, cajoling, schmoozing over soccer games, Stringer talked about how far-flung units must battle Sony's competitors instead of one another. He pointed to the revenue Sony would reap if the company's different arms would cooperate on marketing. It sounds obvious, but his predecessors had failed to pull it off. For Stringer it would take a crisis to finally galvanize his executives into pulling in the same direction: In the battle to replace the DVD Sony would beat back an assault by Toshiba on Sony's Blu-ray technology, the high-definition video format and the linchpin of just about every one of Sony's business lines.
Industrial
Export Boom Fuels Factory Town's Revival Sons and daughters who had abandoned Manitowoc, Wis., are returning with business degrees and breathing new life into old factories. They are part of an American manufacturing revival and they are enjoying export demands thanks to the weak dollar. The economic forces working in favor of U.S. manufacturing include a weaker dollar, which is helping drive sales for exporters and their suppliers. Rising transportation costs are encouraging companies to buy and produce more goods closer to home. An infrastructure and mining boom abroad is boosting orders for the huge cranes made by Manitowoc Co., one of the town's oldest companies. At the same time, rising labor costs in some countries are starting to make outsourcing less attractive. To be sure, American manufacturing has deep problems. Inflation and a sharp slowdown in the U.S. economy are hurting a wide array of producers. Nationally, only about 10% of the U.S. work force is currently employed in manufacturing. That's down from a peak of about 42% in the early 1940s, and about 18% in the 1980s. But while manufacturing now represents about 12% of gross domestic product, down from 15% a decade ago, exports have surged. Last year, the U.S. exported about $1 trillion worth of goods, up 39% from 2002, when the dollar started its decline.
Union Pacific tops forecast Booming shipments of coal, grain and fertilizer coupled to improved productivity drove Union Pacific Corp.'s second-quarter earnings up 19%, despite the impact of rising fuel costs and Midwest floods. The nation's largest freight railroad operator also issued a third-quarter earnings prediction above analysts' current views, expecting strong pricing to counter volumes dragged lower by a softening U.S. economy. The Omaha, Neb.-based company also issued a full-year earnings prediction within a range of what Wall Street expected. Carloads of agricultural products such as grain rose 11% in the quarter. Shipments of energy related products, which include everything from coal to wind turbines, rose 2%. Chemical carloads rose 1%. Shipments of industrial products fell 1%, reflecting the softening U.S. economy. Intermodal volumes, which involve freight transferred between truck and train, fell 6%. But automotive shipments declined by the biggest margin - about 20% - because of the struggling U.S. vehicle market.Total volumes in the quarter dropped by 3%. But the railroad was still able to post higher revenue in five out of six business segments as rates remained strong.
For Materials Companies, a Pinch Coming The list of stocks that investors eagerly follow for news of an analyst upgrade, earnings report, or share buyback probably does not often include Textron. But for those who are fans of the basic materials sector, it would be folly to ignore this industrial company and others like it. Textron shares lost 8.3% Thursday, hitting a two-year low, after the company projected third-quarter earnings to fall short of the current outlook. The company is one of a group of capital-goods stalwarts that have reduced expectations for the third or fourth quarters, which include Eaton Corp., UPS, Deere, and of course automakers such as General Motors. Those companies, analysts say, are cutting back business investment and capital spending as a result of tight financial markets reducing the available capital to invest. In April, about 55% of the nation’s banks reported tighter lending standards for commercial and industrial loans to large and middle-market firms. That’s up from 30% in January and represents a constraint on businesses. So what does this have to do with the commodity-based companies? Those raw materials companies will find the market for their goods diminished as a result of the pullback in the industrial names, and that’s likely to affect the outlook for those shares as well. Investors have started to notice. The Standard & Poor’s 500 basic materials sector ETF has declined by more than 10% since mid-June, although its year-to-date performance still exceeds the Standard & Poor’s 500-stock index. (It had lost 5% headed into Thursday trading; the S&P was down more than 15% year-to-date.) The concern, according to Mr. Levkovich, is that this is a “shift from a housing, consumer and financial sector problem, spreading to the industrial sector of the economy.” The news isn’t uniformly gloomy. Dow component United Technologies Inc. boosted its expectations for the second half of the year, and steel companies have been posting strong earnings on high steel prices.
The Heat Is On GE's Jeff Immelt Immelt faces a range of daunting challenges. After leading GE through a national catastrophe and two recessions, he's now operating in a tumultuous market that's punishing stocks with even a whiff of financial exposure. He is trying to sell consumer finance businesses when potential buyers are skittish. A leader known for his external focus, he must also deal with a raft of pressing internal issues. Not only does GE's eroded stock make it harder to motivate employees in a much-vaunted performance culture, but the current efforts to get out of certain businesses have left more than 50,000 employees in a state of limbo that makes it hard to deliver results. Joseph M. Hogan, president and CEO of the $14 billion GE Healthcare unit, is leaving the company, which could signal more changes ahead. While Immelt, 52, insists that "we're not going to let one quarter define GE," he is making some big moves. On July 10, GE announced plans to spin off the struggling Consumer & Industrial Div., which includes its iconic lighting and appliance businesses, just two months after Immelt said he would sell only the appliances segment. The company is also trying to auction off its $30 billion credit-card unit. Some analysts and investors are ramping up the chatter about selling off NBC Universal, though Immelt says that isn't on the table. Along with the burden of replacing the most celebrated CEO of his generation, Immelt inherited an inflated stock price—the so-called Welch premium—that fostered unrealistic expectations. Yet he has still managed to produce 14% growth in annual earnings and 13% annual revenue gains, on average, over the last five years. He has overhauled the portfolio, buying $88 billion of assets in high-tech growth areas like alternative energy and bioscience while dumping more than $55 billion of less attractive plays such as GE Plastics, his old stomping ground. The GE chief has made a distinct imprint as a manager, leaving executives in the same position longer than the traditional one or two years so they can develop deeper industry expertise while demanding that each business become more customer-focused, as well as more innovative. Slide Show: GE's Generals, Slide Show: GE's Sprawling Empire
United Tech Profit Beats Street, Raises Forecast Diversified U.S. manufacturer United Technologies Corp reported better-than-expected quarterly profit Thursday on solid demand for Otis elevators and fire and security equipment from the commercial construction sector, sending its shares up almost 5 percent. The world's largest maker of elevators and air conditioners also raised its full-year profit forecast, saying it was managing its way through a slowing economy and moderating demand for its aircraft components. "You've got a very diversified company in a variety of different businesses that's extremely well managed," said Jim Huguet, chief executive of Great Companies, a Tampa, Florida-based money manager with about $300 million in assets, including United Tech shares. "I'm not surprised they did well."
Boeing Doesn't Persuade Investors as Optimism About Orders Exceeds Airbus Boeing Co., with about seven years of plane orders, sees fewer cancellations than rival Airbus SAS from airlines coping with a plunge in profits. Investors say they need more evidence. Boeing shares have fallen by more than a third in a year as the second-biggest maker of commercial aircraft delayed its new 787 Dreamliner and lost a $35 billion Air Force contest. Two dozen carriers have folded or sought bankruptcy protection this year and some survivors have scrapped or deferred jet orders to cope with oil costs and weakening economies. ``We do not see upward momentum in Boeing stock until investors regain some confidence in the financial health of the world's airlines and the economic outlook, together with some tangible progress on 787,'' London-based Bank of America analyst Harry Nourse wrote on July 18. Chief Executive Officer James McNerney's commercial- airlines team struck a more positive note at last week's air show in Farnborough, England, where the $64.3 billion in combined orders for Boeing and industry leader Airbus fell short of previous gatherings in Dubai and Paris.
Caterpillar's 2Q profit jumps 34 percent Caterpillar Inc.'s second-quarter profit jumped 34 percent as stronger sales in developing countries outpaced slowing growth in North America, and higher production costs. Caterpillar said its quarterly sales and profit per share set all-time records. "While North America remains depressed, and we've seen softening in Western Europe and Japan, Caterpillar continues to grow in emerging markets and in global industries like energy and mining," Chief Executive Jim Owens said in a statement. Manufacturing costs rose about 1.5 percent due to steeper expenses for steel and other materials, and freight, pushed upward by soaring fuel prices. For the full year, Caterpillar said it now expects revenue of about $50 billion and profit of about $6 per share. The company said it expects raw material costs to swell 2.5 percent to 3 percent in 2008 as a result of higher prices for steel and other commodities. Longbow Research analyst Eli Lustgarten said in an interview the results showed Caterpillar was learning to manage amid difficult cost conditions. But the quarter "wasn't quite as good as it looked," he said, noting a gain from a tax benefit. And the weaker forecast for the rest of the year -- which assumes a federal interest rate cut -- raises questions about the first half of 2009, Lustgarten said. Also Tuesday, Caterpillar said in a regulatory filing it plans to raise prices by 5 percent to 7 percent worldwide starting in January due to "current industry factors as well as general economic conditions."
