The 2014 financial year was a good one, after a couple of poor return years, for shareholders in Australia.
Profits were up with earnings per share growing at 6%.
All good news.
The problem is that sales overall were only up 3%. The healthy rise in earnings was achieved not by a matching rise in revenues but by cost-cutting.
This chart shows the mismatch between sales and earnings per share (EPS):
The cost cutting means fewer staff and this loads more unemployment and lost jobs into the official Australian Bureau of Statistics (ABS) numbers.
It also means fewer dollars spent on suppliers which means fewer dollars circulating and stimulating the economy.
The strategy is all about keeping shareholders happy, and share prices high, by delivering constant profits even if top line growth isn’t there.
Deutsche Bank, in a note to clients, puts it this way:
“There is concern that much of the growth was driven by efficiency programs (6% EPS growth on 3% sales growth), which aren’t a sustainable driver of earnings. And with little sign of a top-line acceleration, the fear is the earnings recovery could fizzle out.”
Australia has been at this trick for just one year. In American, companies have been at longer. US firms have generated EPS growth of 9% from modest sales growth of 5% for almost four years now.
Deutsche Bank says efficiency programs are likely to support EPS growth above sales growth for a few more years, as Australia follows the US path.
This should help buy time, and keep share prices up, until sales growth improves.
Deutsche Bank says says an improvement seems likely at some stage, if only as the mining parts of the economy stop declining.
Analysts are forecasting a small uplift in sales growth in the current financial year and in 2016.
But a key question is how deeply can companies cut costs before operations are disabled?
Deutsche Bank says Australia likely has a more inflated cost base than the US to work with.
Australia’s expansion during 2003-07 was a lot stronger than in the US and Australia’s economy recorded a far more modest slowing during the 2009 global recession.
Inefficiencies tend to creep in during the good times as businesses focus on meeting demand and defending market share. But now that the economy is slowing, there’s more focus on the cost base.
For some companies this means mass layoffs. For others, it’s “rationalisation” and “streamlining”, and sending operations offshore where labour costs are lower.
To show how common the strategy is, the DB team compiled this list of what precisely various companies are doing to protect their margins. Below, with minor edits, is what they presented as evidence. It’s a confronting list.
AMP: $200 million of costs. Rationalisation of staff numbers, especially in legal and Human Resources. Focus on more efficient processing, outsourcing more (such as IT) and lowering fees paid to asset managers.
QBE: Operational transformation aimed at developing a simplified and unified operating platform and saving US $250 million. Involves moving functions offshore to the Philippines including call centres, processing of policies and claims, and also some accounting functions.
Seven West Media: Bringing together the newsroom for The West Australian and Channel 7 Perth over the next year which will reduce duplication and rent costs.
Boral: Cost-out program ongoing with savings of $105 million so far, focused on rationalising and streamlining overheads. Reduced staff by 1,100, primarily from support and management. Savings flowing from improved procurement and contract management. Moved some manufacturing offshore (engineered flooring which had been done at Murwillimbah) and exited woodchip business.
BHP/Rio Tinto: Shifted approach from maximising revenue in a strong environment to managing costs given softer demand. Reducing staff numbers in head office. Cutting back on consultants and contractors. Working assets harder by improving maintenance schedules. Reducing procurement costs by buying equipment from China rather than the US. Reducing working capital by carrying less inventory and spare parts.
Banks: Continue to focus on improving efficiency through improved IT systems and better processes (less paperwork). As an example, previously it took 19 steps to process a home loan, but this has been cut to 10. Product simplification is also ongoing: NAB had 500 core banking products in 2009 which dropped to 237 in 2012, and the target is less than 100; and Westpac has cut back to an offering of only three different credit cards. This simplification reduces processing costs, and increases branch efficiency as staff have fewer products to deal with. Banks (excluding the Commonwealth) continue to offshore some operations to reduce costs. Banks are building campuses to bring people together, saving time on staff interactions. Around 10% staff churn per year and banks are trying not to replace departees. The floor space of branches is being wound back as customers increasingly use internet banking. Continued focus on better procurment of stationery, furniture, equipment. Continued outsourcing of IT processes to third party providers,
Asciano: Integrating coal haulage operations, which will leave a single area with responsibility for all procurement and maintenance, thus reducing duplication. Replacing half of the workforce at Port Botany with equipment (automated straddles).
Aurizon: Transformation from a government-owned company seeking to maximise coal volumes (as govt benefits from royalty stream) into a public company maximising profitability. Voluntary redundancies now in the past, but ongoing efficiencies are being pursued (eg, reducing maintentance time, reducing closure times, using IT to report faults more quickly).
Brambles: Targeting $100 million of cost-out over a fiveyear period, which will largely come from cutting corporate overhead costs from each division. The company is also looking to improve and streamline IT systems (have had more than a dozen different payroll systems).
Contractors: Reducing headcount in response to softer demand. Site consolidation (both factories and office) has reduced rent costs. Saving on supplier agreements by paying invoices earlier (30 day rather than 60 day cycle).
Graincorp: Project Regeneration is underway, which involves closure of storage terminals, headcount reductions, largely motivated as catch-up capex to drive efficiency and streamline logistics in light of increasing competition.
Qantas: Reducing staff numbers by around one-third in head office. Exited loss-making routes like Sydney-Auckland-Los Angeles and Hong Kong-London.
SAI Global: Has made several acquisitions over the years and had siloed cost structures. Now looking to cut duplication of HR/legal/payroll.
Toll: Project Forward is focused on the freight-forwarding business. The company have previously invested considerable cost into growing the business globally (had sales staff in small European countries producing little revenue), but is now reducing the cost base.
APN News & Media: In June 2014, the company announced an agreement with Fairfax to share NZ printing presses.
Fairfax Media: Selling printing assets (Tullamarine and Chullora) with printing shifting to regional sites as newspaper circulation continues to decline. Sharing content across newspapers and printing fewer newspapers. Implementing a flatter management structure for the Australian Community Media (ACM) business, including limited consolidation of papers where there is a significant overlap of readership. The ACM changes expect to deliver annualised savings of around $40 million by 2016
Nine Entertainment: Combining the sales platforms for TV and digital advertising. Lowers staff requirements, and increases scope for cross-selling.
Ten Network: Reducing staff numbers by around 150 over the next year as part of a News and Operations review and restructuring.
AMP: Company is attempting to take out $200 million of costs. Rationalisation of staff numbers, especially in legal and HR. Focus on more efficient processing, outsourcing more (IT) and lowering fees paid to asset managers.
IAG: Previously, Personal, Commercial and NZ each had their own support staff to manage supply chains, procurement, HR, legal, payroll etc. But IAG is now creating a 4th division called Enterprise Operations as a centralised support area, thus reducing duplication. IAG is also rationalising systems after acquisition of the Wesfarmers’ insurance business.
Perpetual: The project Transformation 2015 is close to complete. Reduced headcount by around one-third, with little apparent impact on revenue.
Suncorp: Has a Simplification strategy aimed at saving $265 million in financial year 2016. SUN is consolidating insurance licences, replacing bank IT system and legacy systems, harmonising group procurement and implementing group operational efficiency.
Arrium Steel: Cost reduction program ongoing. Costs taken out by forming a single steel business (previously manufacturing was separate from distribution). Targeting further labour and overhead reductions, site rationalisation, better procurement. More announcements are possible given the balance sheet position of the company.
Fletcher: Unite business transformation programme ongoing. Reducing cost base through centralising common functions. Expect pre-tax benefits of $25 million in the current financial year, and $100 million a year by 2018. Have already centralised property management team covering 1000 properties across NZ and Australia. Have completed new IT and digital strategy. Focusing on better procurement.
Orora: Has already taken costs out via plant closures / portfolio restructures (exiting loss making businesses – import sourcing is cheaper, and don’t need as much tonnage given declines in paper use). New paper mill (more cost efficient) is undergoing ramp up, which should drive further efficiency gains over the next 2-3 years.
Sims: Exiting loss-making Electronics Recycling businesses in UK and Canada, and consolidating New Jersey and Texas small scale feeder yards with other sites. In Metals business, consolidating 7 operating regions to 3, which reduces overhead costs. Divested Utah facility and looking to sell Alabama facility.