Corporate America has managed to deliver sky-high profits on little revenue growth thanks to expanding profit margins.
Cheap debt, low tax rates, and increased productivity have fattened profit margins to record levels.
While managers believe margins can move higher this year, their conviction behind that call seems increasingly shaky.
“Companies once again presented mixed outlooks for margins, but many indicated that expansion will be difficult,” said Goldman Sachs’s David Kostin citing earnings conference calls. “Consistent with our forecast that profit margins will remain roughly flat near historical peak levels for the next two years, managements highlighted difficult pricing and higher input costs as key factors offsetting operating leverage, efficiency gains, and continued cost controls.”
Without revenue or margin growth, there can be no profit growth, which is arguably the most important long-term driver of stocks.
Market bears have been warning that margins are doomed to contract sooner or later.
Kostin’s note included quotes from some of the calls. Here are a few he pointed to:
McDonald’s Corp: We’re diligently managing restaurant expenses, but we expect cost increases to continue pressuring margins in 2014.
Nike Inc: …We will be facing new pressures as raw material costs shift from tailwinds to headwinds and we increase discounts to clear pockets of excess inventory. We also expect to face continued pressure from labour costs and foreign exchange.
Ford Motor Co.: In North America, we also expect net pricing in 2014 to be slightly unfavorable as we run out outgoing models and assume a continuation of a more competitive pricing.
Johnson & Johnson: We also expect to experience pricing pressures in 2014 across many markets, particularly in Europe. The impact of this negative pricing pressure is expected to negatively impact our pre-tax operating margins by approximately 50 basis points.
Wells Fargo & Co.: Our gain on sale margin was 1.77% in the fourth quarter, up from the third quarter but lower than historical elevated levels we experienced in the second half of 2012, and the first half of 2013. While there are a lot of factors that impact the margin, we currently expect margins in the near-term to remain in the range we saw in the second half of 2013.
Schlumberger NV: The main challenge in the North American land market is still in pricing, and we saw further downwards pricing pressure in most product lines in Q4…
General Mills: Gross margin, excluding mark-to-market effects, declined 100 basis points. This is primarily due to higher input costs and unfavorable mix.
All of these were excerpted from Goldman Sachs’ S&P 500 Beige Book, a collection of anecdotes from earnings conference calls.