Transcript Document

Outlook for US Corporate Profits
Which are the Leading Sectors?
Mark Killion, CFA
Managing Director
April 29, 2003
Copyright ©2003 Global Insight, Inc.
Outlook for US Corporate Profits
Agenda:
 Corporate Profits are key to:


understanding asset valuation, credit quality
anticipating the CapEx cycle and employment growth
 Corporate GAAP Profits (SEC) are more volatile than NIPA
Operating Profits (IRS via BEA)

What have been the recent trends in each?
 ROE Framework to analyze the prospects for corporate profits

Impact of operating leverage and financial efficiency
 Which sectors are winners and losers?
Copyright ©2003 Global Insight, Inc.
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Two Measures of US Corporate Profits
S&P 500 US$ Earnings Per Share
US Domestic Corporate Profits US$ Billion
55
1100
50
1000
45
Profits as S&P 500 GAAP (EPS, LHS)
900
Corporate GAAP Profits (filed
with SEC) are more volatile
than NIPA Operating Profits
(filed with IRS and used by
BEA) due largely to Balance
Sheet impacts
40
800
35
700
30
600
Recent examples:
25
500

20
400

15
300
10
200
5
0
Profits as NIPA (Bill.$, RHS)

100
0
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
E
Profits as S&P 500 GAAP from SEC (EPS, LHS)

2000 -- Goodwill Write-Offs,
Decline in Credit Quality
2001 -- Corporate Fraud,
Asset Impairment,
Bankruptcy & Bad Loans
2002 -- Expensing Stock
Options, CEO Certification,
E&O Insurance
2003 – Year of Pension
Expense Adjustment,
Change in Executive
Compensation Structure
Profits as NIPA from IRS via BEA (Bill.$, RHS)
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How are Profits Faring in the Business Cycle?
National Profits Growth Rate (LHS), and
Profits as Shares of Income (RHS)
How Does the Current Profit Recession Compare to
the Previous Profits Recession of 1988-1992?
(Percent)
25
16
20
15
15
14
U .S. Corporate Profits in Quarters After Cycle Peaks (88-92 Vs. 97-02)
(Index = 100 at Cycle Peak of Corporate Profits: 1988 Q4 and 1997 Q4)
140
10
13
12
0
11
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
5
Index 100 = Cycle Peak
130
120
88Q4- 92Q1 -- With CCA Adj.
110
100
-5
10
-10
9
-15
8
70
-20
7
60
97Q4 - 02Q4 -- With CCA
Adj.
90
80
97Q4 - 02Q4 -- No CCA Adj.
-7 -6 -5 -4 -3 -2 -1
0
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20
Number of Quarters Following Peaks of 88Q4 & 97Q4
Current NIPA Corp. Profits Growth (LHS)
Profits Share of Corporate GDP (RHS)
1
Index for 1988 Q4 to 1992 Q1
Index for 1997 Q4 to 2002 Q4
1997 Q4 to 2002 Q4--No CCA Adjustment
Corporate Profits Share of Nat'l Income (RHS)
Copyright ©2003 Global Insight, Inc.
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The Adjustment for Capital Consumption (to fit “bottom up”
Profits with “top down” GDP) Has Become Unreliable
Capital Consumption Adjustment to U.S. Corporate Profits
Adjustment from Tax-Based to Economic Depreciation Rates. A Postive Number Indicates a Boost to
NIA Corporate Profits by Taking Back Some Depreciation Claimed aginst Profits
140
35.0
120
30.0
100
25.0
CCA Adjustment in US$ (LHS)
80
20.0
60
15.0
40
10.0
20
5.0
CCA Adjustment as % of Base
0
1987
1988
1989
1990
1991
1992
1993
CCA Adjustment in US$ (LHS)
1994
1995
1996
1997
1998
1999
2000
2001
Adjustment as % of Profits
Adjustment in Bill. US$
(Corporations Report Tax-Based Depreciation Lower Taxable Profits)
0.0
2002
CCA Adjustment as % of Base (RHS)
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Which US Sectors are Generating Profits?
Sectors with Positive and Steady Profits
Sectors with Positive and Improving Profits
(Billions of US$)
(Billions of US$)
250
250
200
200
150
150
Wholesale Trade
100
Food & Related Products
Financial NonBanking
Electricity & Utilities
Receipts from Rest of World
100
50
50
0
0
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
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Which US Sectors are Seeing Profits Weakness?
25
20
Sectors where Past Losses are Turning into
Profits Recovery
Sectors with Steady Profits Now Under
Moderate Pressure
(Billions of US$)
(Billions of US$)
Electronic & Electrical
Steel & Metals
Transportation Services
100
90
80
70
15
10
60
Banking (In Federal Reserve System)
50
Retail Trade
40
5
30
0
-5
-10
20
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
10
0
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
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Which US Sectors are Generating Profits?
40
30
Sectors With No Recovery Yet in Profits
Sectors with Exposure to Oil Related Factors
(Billions of US$)
(Billions of US$)
Industrial Machinery & Equip.
Motor Vehicals & Parts
Communication Services
35
Petroleum & Coal Products
Chemicals & Products
30
25
20
20
10
15
10
0
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
5
-10
0
-20
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2001- 2002- 2002- 2002- 2002I
II
III IV
I
II
III IV
Copyright ©2003 Global Insight, Inc.
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Return On Equity (ROE) as Measure of Profitability
“DuPont System” ROE Framework shows the rate of return that
management earns on capital provided by the shareholders
(Profits calculated relative to the equity interest, after accounting for payments to all other capital suppliers)
DuPont Ratio Interpretation:
ROE Framework Identity:
ROE is always described by some combination of:
Return on Equity (NI/Equity) =
profit margins, reflecting efficiency in production, the mixture
of fixed versus variable cost and/or the presence of pricing power
Profit Margin (NI/Sales) *
asset turnover, showing the degree to which company assets
are generating sales
Asset Turnover (Sales/Assets) *
financial leverage, showing the extent to which the asset base
Financial Leverage (Asset/Equity)
is financed by debt
Where: NI = Net Income; Equity = Book Value of
Equity, Valued at the End of the Preceding Period;
Assets are Total Current Period; Sales are Gross;
In this framework, the component “DuPont” ratios
outline the relationship that profits have with sales,
pricing power, balance sheets and industry structure.
( * Denotes a multiplication sign)
Copyright ©2003 Global Insight, Inc.
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Return On Equity shows rate of return that management
earns on capital provided by the shareholders
What has been the Return on Equity
Performance?
US Corporate Return on Equity
Total for 1500 US Corporations in the
GICS Sector Classification Scheme
ROE in %
Component Ratios
4
6
3
4
2
2
1
0
0
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
8
2001
5
2000
10
1999
6
1998
12
1997
7
1996
14
1995
8
1994
9
16
1993
18
1992
10
1991
20
US Posted Excellent ROE record through 1997:
Problem of Falling Asset Efficiency, related to M&A purchases
and CapEx spending
Largely offset by Production Efficiency, Rising Margins
Increase in Operating Leverage
Pressures on margins built up from Mid 1990s:
Compression from Asian / Russian crises in 1998
Increase in Financial leverage to compensate
What Happened in 2001-2002?
High operating leverage killed margins when growth slowed
Deteriorating credit quality and corporate malfeasance
Markets forcing a de leveraging of balance sheets
Copyright ©2003 Global Insight, Inc.
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Sector Level Return On Equity shows some saints
and sinners
ROE Telecommunication Services
ROE for Health Care
Total for all US Corporations in the
Telecommunications GICS Sector
Total for all US Corporations in the
Health Care GICS Sector
ROE in %
Component Ratios
30
15
ROE in %
Component Ratios
30
15
27
25
24
12
10
21
20
18
9
15
5
15
12
6
10
9
0
6
3
5
3
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0
1991
0
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-5
1991
0
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
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Sector Level Return On Equity shows a tale of two
different consumer sectors
ROE for Consumer Discretionary
ROE for Consumer Staples
Total for all US Corporations in the
Consumer Discretionary GICS Sector
Total for all US Corporations in the
Consumer Staples GICS Sector
ROE in %
Component Ratios
30
15
25
12
20
ROE in %
Component Ratios
30
15
25
12
20
9
15
9
15
6
6
10
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
2001
2000
1999
1998
1997
1996
1995
1994
0
1991
0
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0
1991
0
3
5
1993
3
5
1992
10
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
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How Much Financial Leverage Will Markets Allow?
Which Sectors have Restructured
their Balance Sheets?
Measures of Financial Leverage
Totals for 1500 US Corporations in the
GICS Sector Classification Scheme
8
Sectors that have not materially increased
their leverage, remain in good shape
2
Health Care
Financials (Used Leverage 1996-7 but quickly unwound it)
Consumer Staples
7
6
1.5
5
Sectors that had increased leverage in late
1990s, but have now reversed that trend:
4
Energy
Information Technology (used equity not debt)
1
3
2
Sectors with significant financial leverage:
199
1
199
3
199
5
199
7
199
9
200
1
0.5
Interest Expense as % of Total Expense
Financial Leverage Ratio (Asset/Equity)
Ratio of Debt to Equity (RHS)
Consumer Discretionary:
Autos in bad shape
Media is reforming
Sectors with Assets (A/E) Down, but Debt (D/E) Up:
Capital Goods
Industrial Materials
Telecommunications
Utilities
Copyright ©2003 Global Insight, Inc.
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How Will ROE Rise From Here?
 Improvement in Profit Margins remains the most likely source
of near term earnings growth:



This economy was built for speed – interaction among operating leverage,
capacity utilization, profit margins
Significant cost reductions already achieved
Many sectors will need growth in CapEx to generate profits increase
 Financial Re Structuring has been in vogue, but will markets
allow for additional debt?



CapEx increasingly funded with retained earnings
Return on Investment receives greater scrutiny by investors
Raising the profile of net income relative to current operating profits
 Asset turnover is at low point, there is room to rise from here,
but long term trend is down


Already quite a lot has been accomplished in asset re pricing, adjustments
for credit quality, impairment write-offs
Yet any sizeable increase in M&A and CapEx will limit room for much
further improvement in asset efficiency
Copyright ©2003 Global Insight, Inc.
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Outlook for US Sector Profits
Sector Profits Set for a Cyclical Rebound
(Average Percent Growth of US Sector Operating Profits, Top 10 GICS Economic Sectors)
All Commerce
Utilities
Telecomm's
Technology
Financial
Health Care
Cons. Discretionary
Consumer Staples
Industrials
Materials
Energy
-10
-5
1998-2000
0
2001-2002
Copyright ©2003 Global Insight, Inc.
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2003
10
2004-2007
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Title Goes Here
Thank you!
Mark Killion, CFA
Managing Director
World Industry Services
Global Insight, Inc.
Phone: 610 490 2547
email: [email protected]
Copyright ©2003 Global Insight, Inc.
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