How far can cost-cutting get you in a slowing economy?That’s the question the U.S. manufacturing sector will answer over the coming weeks. Through the first half of the year, big industrial companies including General Electric Co, United Technologies Corp and Caterpillar Inc notched impressive profit growth despite shaky demand, largely thanks to their success in boosting productivity.
But that bit of management magic may have run its course – Wall Street expects manufacturers to report a sharp slowdown in earnings growth in the just-ended third quarter, as Europe’s deteriorating economy, slowing growth in Asia and the risk of the United States going over a self-imposed fiscal cliff cause customers to throttle back spending even further.
Warning signs abound. In recent weeks, Caterpillar, United Tech and FedEx Corp have noted that the world economy is slowing – and that they are bracing for an extended period of tepid growth.
FedEx, the world’s No. 2 package-delivery company, this week unveiled plans to cut costs at its air-express operation by about $1.7 billion over the next four years, because it no longer expects that business to maintain its prior growth rate, which was twice that of global GDP growth.
Despite those cost-cutting plans, analysts expect profit for FedEx’s 2013 fiscal year, which ends in May, to be roughly flat after rising about 40 per cent in fiscal 2012 – suggesting that belt-tightening can only do so much to offset a weak economy.
“We are operating in the most tepid post-recession recovery in the modern era,” David Bronczek, who heads the company’s air express arm, told investors.
Others have been more bullish – GE late last month raised its full-year sales growth target, saying demand for jet engines, electric turbines and other heavy equipment has held up despite a tricky global economy.
Wall Street has ratcheted down its expectations for the manufacturing sector during the quarter and now looks for the industrial companies in the Standard & Poor’s 500 index to collectively report 1.9 per cent earnings growth, down from a forecast of 3.7 per cent as of July 1, according to Thomson Reuters I/B/E/S.
That would represent dramatically slower growth than the 14.8 per cent growth notched in the second quarter and 17.4 per cent increase recorded in the first quarter of 2012.
ON THE BRINK
Adding to CEOs’ worries is the U.S. fiscal cliff, Washington’s self-imposed deadline to agree on a plan to shrink the federal budget or trigger $600 billion in spending cuts and higher taxes to take effect the beginning of January.
While the spending cuts would pose the greatest challenge to companies with defence operations, such as Honeywell International Inc and Textron Inc, economists and investors fear the cutbacks could ripple across the economy, prompting businesses of all kinds to rein in spending.
“How our politicians handle that fiscal cliff can either be a potential opportunity or could be a disaster and I think could spark a global recession if it was handled really poorly,” Honeywell CEO Dave Cote said in an interview in Dhahran, Saudi Arabia this week. “I’d like to be more optimistic and say I don’t think that kind of a disaster will happen.”
Concerns about the fiscal cliff contributed to a third-quarter weakening of demand for a wide variety of industrial goods, from heating and cooling equipment to pumps, a survey of equipment distributors conducted by Barclays Capital found.
“Outlook for the remainder of the year remains highly uncertain,” said Barclays analyst Scott Davis. “We think this is a mid-cycle slowdown which is larger than we had expected but not the end of the cycle.”
Concerns about slowing profit growth have begun to weigh on industrial shares. After running up by about 24 per cent in the six months spanning the fourth quarter of 2011 and first quarter of 2012, the S&P capital goods index has flattened out and is now up about 20 per cent for the past 12 months, in line with the broader S&P 500.
Oliver Pursche, president of Gary Goldberg Financial Services, which manages about $600 million in assets, said he expects industrial shares to slump in the coming months.
“We’re not particularly bullish on material and industrial stocks at this point in time,” Pursche said. “If you look at the big rally that we saw in the fourth quarter of last year and the first quarter of this year, we think we’re more likely to see a selloff in part as a result of the global macro picture.”
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