Profit picture clouded, despite end of recession

Louis Proyect lnp3 at
Mon Apr 1 07:26:11 MST 2002

WSJ, Apr. 1 2002

Businesses Sing Bottom-Line Blues
As Profit Crunch Haunts Recovery


Evidence is mounting that the U.S. economy is barreling out of recession
much sooner than expected. But executives at some of the nation's biggest
businesses aren't breaking out the champagne.

That's because the mildness of the recession masked a ferocious
corporate-profits crunch that has many chief executives still slashing jobs
and other costs. If they continue, the cuts could slow the recovery.

Consider Emerson Electric Co., a St. Louis manufacturer of garbage
disposals, telecommunication equipment, motors and other products. Until
last year, Emerson boasted a legendary run of 43 consecutive years of
profit growth. The recession ended the streak, and the company has
responded with a sweeping restructuring plan. In January, it said it would
close 30 plants and move much of its production to Mexico and China, where
costs are much lower. These moves follow the closing of 20 Emerson plants
last year.

Like many companies, Emerson expects profits to improve this year. But as
is common across industries, its profit gains won't make up for the 27%
decline in net income Emerson posted last year.

After the Boom

Many executives grew accustomed to the idea of double-digit profit growth
during the 1990s boom. Now those days of inflated expectations are gone,
and CEOs are more cautious. "Our major emphasis continues to be on
implementing restructuring," David Farr, Emerson's chief executive, told
investors in February.

The recession of 2001 will probably turn out to have been one of the
mildest on record in terms of gross domestic product, or the total value of
goods and services produced. GDP actually grew 1.2% last year, according to
the Commerce Department.

But the recession was one of the harshest in memory when measured by
changes in profit levels. The Commerce Department said aftertax corporate
profits declined 15.9% last year, one of the worst annual profit declines
since World War II. (The decline was exacerbated by government accounting
for recent tax-law changes.)

Among the mostly large companies making up the Standard & Poor's 500-stock
index, the profit plunge was especially bad. Reported aftertax income last
year fell by nearly 50%, or $208 billion, to $225 billion. This drop was
exacerbated by massive write-offs for such things as excessive equipment
purchases during the boom and anticipated plant closures and layoffs.
Shellshocked CEOs determined not to repeat embarrassing write-offs are wary
of any new spending.

Pumped-Up Profits

Some of those write-offs reflected companies coming to grips with dubious
accounting methods they used in the 1990s to inflate profits. In those
instances, pumped-up profits in past years make current results look even
less impressive. And, after the Enron Corp. scandal, Wall Street's
heightened focus on accounting may prompt companies to report their results
more conservatively.

"The profit environment has been brutal," says John Lipsky, chief economist
at J.P. Morgan Chase & Co. in New York. And while Mr. Lipsky and many other
economists say profits are already improving, the hole from which companies
must emerge is so deep that it's hard for top executives to muster much
optimism. "They're not going to take an upbeat view on the economy until
the profit outlook is more upbeat," Mr. Lipsky says.

So far, strong consumer spending seems to be pulling the economy out of
recession. A full-fledged recovery requires the revival of corporate
spending, as well, economists say. Increased corporate spending typically
requires strong profits. But many CEOs were so traumatized by last year's
profits debacle that they are paring costs rather than planning plant

Earlier this month, General Motors Corp. said it would eliminate another
1,800 salaried jobs by attrition to compensate for continued discounting on
car prices. Last year, GM laid off 2,700 white-collar workers. While the
stock market is gradually improving, Goldman Sachs & Co. said this month it
would sack as many as 1,360 workers this year. Black & Decker Corp., the
appliance and tool maker, said in January that by 2004 it would shut down a
quarter of its production capacity, mostly in the U.S. and the U.K., and
shift a large portion of what remains to Mexico, China and the Czech
Republic. Hundreds of other companies are taking similar steps.

"Almost all of the business people that I talk to remain extremely
cautious," says William Esrey, the chairman of Sprint Corp. and head of the
Business Council, which represents large corporations. The Business Council
says 56% of the executives it polled in February planned either to cut
their work forces or to hold them steady this year. Fifty-three percent
planned to cut capital spending.

This caution probably won't stop the recovery, "but I do think it puts a
speed limit on it," says Maureen Allyn, chief economist at Zurich Scudder
Investments, the money-management firm.

Part of the problem for companies is that many of the trends that caused
profits to collapse last year continue today. Intense global competition
and excess capacity in factories and retail space make it difficult for
companies to raise prices. Meanwhile, the costs of wages, health care and
other worker benefits have proven stubbornly difficult to bring down. Added
to that, a strong dollar continues to hurt U.S. companies' profits overseas.

These developments have been a boon to American consumers, who have enjoyed
lower prices. For companies, however, these trends have "worked like two
blades of a scissors to slash [profit] margins," says Ms. Allyn. "Repair is
under way," in the form of cost-cutting programs, she says, but many
companies are far from finished.

Labor costs are a big source of corporate anxiety. Since 1997, labor costs
at American companies have risen by 13%, pushed higher by a tight labor
market and rising health-care costs, according to the Labor Department. At
the same time, companies have been able to raise prices by only 6%, the
department says. This squeeze contributed to corporate profit margins
falling to near-record lows.

Companies have begun to address the problem by eliminating jobs. Labor
costs fell in the fourth quarter for the first time in two years, the Labor
Department says. But unremitting health-care costs and a still-tight labor
market pose a continuing challenge.

Human Consequences

Belt-tightening can have harsh human consequences. Susan Love has worked at
Emerson's Rollway Bearing plant in Liverpool, N.Y., for nearly 30 years.
The 55-year-old supply manager and her husband had planned to retire in two
years and open a campground at a lake in upstate New York. But they need
another $20,000 to finish work on the campground. Her husband lost his job
at another plant in February. Then on March 8, Emerson executives gathered
Rollway Bearing employees in the company cafeteria to tell them the factory
would close by the end of the year.

"It was like a punch in the face," says Ms. Love, ordinarily a cheerful
woman. Now, she worries whether she and her husband will have enough money
to retire as soon as they had planned.

Some of today's corporate pessimism could melt if profits return strongly.
Most Wall Street analysts predict profits will bounce back to pre-recession
peaks by 2003. The Commerce Department reported fourth-quarter profit
figures last week that indicated signs of improvement near the end of last

Small companies offer reason for optimism too. A recent survey by the
National Federation of Independent Business, which represents small
companies, found that 55% expected the economy to strengthen in the next
six months. Moreover, the cost-cutting in companies small and large could
improve productivity, which in the long term benefits the economy.

Short-Term Pain

But improvement won't come without more pain in the short term. Look at
Albertson's Inc., the nation's second-largest supermarket chain, after
Kroger Co. When Larry Johnston ended a 28-year career at General Electric
Corp. last April to become Albertson's chief executive, the company was
struggling to digest its 1999 acquisition of American Stores Inc., another
large grocery chain. Albertson's was also beginning to feel the forces of a
profit vise that had already started to squeeze many other industries.

Revenue was pinched as consumers traded down to cheaper products at its
grocery stores and discounters such as Wal-Mart Stores Inc. offered more
competition. At the same time, Albertson's costs -- most notably labor
expense at a company that employs more than 200,000 people -- were rising.
For 2001, health-care expenses came in $25 million above budget, the
company says.

Shortly after he came on board, Mr. Johnston responded by setting up what
he calls expense bullet trains: teams of executives assigned to scour every
company expense line, from travel to utilities to leases, and report
directly back to him on ways to reduce costs. In July, he announced plans
to close 165 stores in 25 states and cut 15% to 20% of the company's
salaried workers, in addition to thousands of hourly store workers.

While the economy appears to be turning around today, Mr. Johnston says he
still feels pressure to cut. He expects health-care expenses to rise 16%
this year, to $67 million. The economy appears to be near the turnaround
point, he says, but "whether we're headed back up or not is hard to say."

So, with the company still only halfway through carrying out the closings
and layoffs announced last year, Mr. Johnston declared a second wave
earlier this month. The company will get out of markets in San Antonio,
Houston, and Nashville and Memphis, Tenn. It will close 116 more stores,
laying off several thousand more people and taking a $580 million charge,
on top of the $585 million charge it took last year. By 2003, Mr. Johnston
says, his company will save $500 million a year as a result of these changes.

Even if the economy rallies, it won't return companies -- particularly in
high technology -- to the stratospheric days of the tech bubble. Novellus
Systems Inc. makes the gear for $1 billion facilities that churn out
computer chips and the insides of cellphones. The San Jose company reported
in February that its orders would be as much as 40% higher in early 2002
than they were at the end of 2001. But after last year's tech collapse,
orders are still down more than 60% from their peak in 2000.

CEO Richard Hill says even though the tech sector is recovering, he won't
step up production. Instead, he plans to reduce inventories by $80 million.
After cutting $100 million last year in overhead expenses -- such as
advertising, travel and administrative salaries -- he says he will hold the
line in that area this year.

Drilling a Hole

Black & Decker, based in Towson, Md., announced in January that its net
income had dropped 62% in 2001. The prices it was able to charge on power
tools and other products fell 2% in the face of tough competition from
overseas. That might not sound like a lot, but for a company that registers
$4 billion a year in sales, it can drill a big hole in the bottom line. At
Black & Decker, operating profits would have been $87 million higher last
year if it had been able to hold prices steady.

In response, Black & Decker in January announced its broad plant closures.
The price tag: $190 million in pretax charges for restructuring that won't
be complete until 2004.

When the Sept. 11 terrorist attacks sent hotels' occupancy rates tumbling
last fall, Barry Sternlicht, chief executive of Starwood Hotels & Resorts
Worldwide Inc., directed 300 in-house efficiency experts to find new ways
to cut costs. Even before the attacks, Starwood was cutting prices, as
business travel declined and hotels had to seek leisure travelers at lower
prices. Starwood's average room rate fell to $143 from $164 last year.

Starwood eliminated 800 middle-management positions and nearly 10,000
housekeeping and clerical jobs last year. Occupancy rates have been picking
up recently, and many of the low-end workers have been hired back, the
company says. But Dan Gibson, its director of investor relations, says
Starwood won't go back to business as usual. Capital-spending plans have
been trimmed 47% for 2002, to $300 million. And the 800 middle managers
won't be hired back.

"We are not just sitting back, waiting for the business cycle to carry us
out of this downturn," Mr. Gibson says. Starwood's earnings per share
dropped 64% last year, to 73 cents. The company expects to report a
significant bounce, to $1.30 per share, this year, but that would still
leave it 35% short of 2000 levels.

Even some companies that have improved their efficiency by restructuring
are still looking for more cuts. Norfolk Southern Corp., a rail carrier
based in Norfolk, Va., revamped its schedules last year so its trains would
spend more time on the tracks, rather than sitting idle in yards. It was
able to reduce its fleet of freight cars by 12,000, or 10%.

Now, rail traffic is showing signs of turning up, but CEO David Goode says
he isn't going to increase his fleet. He found that his company had become
so efficient, he could eliminate another 860 cars this year, reducing
maintenance expenses and rail fees in the process. The company says it may
reduce some jobs through attrition, as well.

"There is nothing like a business slowdown to focus the mind," Mr. Goode says.

Louis Proyect
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