A disconcerting trend lurks beneath the recent round of solid profit forecasts announced by companies ranging from United Technologies Corp to Wendy’s Co. More than three years into the recovery, CEOs are still relying on cost cuts to prop up earnings, reports Reuters.
While the cuts are not as severe as those that followed the 2008 financial crisis, companies remain cautious, mindful that revenue growth is still tepid. As a result, many appear to be more comfortable wringing efficiencies out of their businesses than gearing up for accelerated production.
The risk is those cuts may be too deep at this stage in the economic cycle, and prevent companies from responding if and when demand takes off.
‘Corporate America has cost-cut just about as much as they can,’ said Jeffery Saut, chief investment strategist at Raymond James Financial. ‘I think the economy is going to pick up, and if you’re understaffed and don’t have enough throughput in your factories, yeah, I think you’re going to miss out on some things.’
Of course many companies, including Coca Cola Corp and 3M Co, are expecting an uptick in demand through next year. US business spending on capital goods is rising and even Europe is showing some very early signs of life.
Thomson Reuters data shows that revenue growth among S&P 500 companies over the next six months is expected to rise 2.2 per cent, and 3.9 per cent in the first six months of 2014. That compares with the 0.8 per cent rise that companies posted from January through June of this year.
But the brightening forecasts aren’t stopping many companies – even those with bulging order books like Boeing Corp. (BA.N) and General Electric Co (GE.N) – from remaining defensive.
Boeing, which employs about 174,000, has said it expects to cut more workers this year than the 8,000 to 10,000 it plans to hire. And GE Chief Executive Jeff Immelt told analysts this quarter that cost controls were one of the company’s ‘execution levers,’ given that he sees no improvement in the business environment for the rest of the year.
‘There is continuing concern about the economy,’ said Chad Moutray, chief economist for the National Association of Manufacturers. ‘There still is a bit of a wait-and-see approach out there.’
The cost cuts are not necessarily through jobs. In fact, US employment gains in the first half held steady at about 200,000 a month. Even though growth has slowed in recent months, some economists say many businesses have no choice but to beef up staff, after aggressively wielding the axe during the 2007-2009 recession.
Those reductions were part of a brutal cost-cutting cycle that helped businesses build a $1.8 trillion cash stockpile. Analysts say firms still want to hold the line on costs, but now have little choice when it comes to hiring.
To compensate, some US companies are paring back elsewhere. Ford Motor Co closed two British factories this week and plans to close one in Belgium by the end of next year. Meanwhile, it is looking to hire 3,000 US salaried workers this year.
Instead of layoffs, Wendy’s said on Tuesday it would sell 425-company operated stores to franchisees to save money.
And General Electric Co said it planned to cut costs this year with a mix of layoffs, coordination of large purchases of supplies and its ‘simplification program,’ though the conglomerate declined to provide details.
In calculating strategy, revenue is crucial. Among industrial companies that reported quarterly results as of Wednesday, revenue rose only 1.3 per cent, according to Thomson Reuters data.
‘The absence of revenue growth is what’s driving the cost cuts,’ Vertical Research Partners analyst Jeff Sprague said. ‘Companies continue to run things very tightly. They can’t control the macro, so they’re trying to control what they can.’
In general, S&P 500 companies are expected to post revenue increases of 1.6 per cent this quarter against an estimated 4.1 per cent profit increase, according to Thomson Reuters I/B/E/S.
‘Investors are expecting a certain return,’ said Greg Harrison, senior research analyst for Thomson Reuters. ‘When revenue is not growing and the economy is growing slowly, the only way to give them that return is to cut costs or buy back shares.’
Take United Technologies. The diversified manufacturer earlier this week lifted its full-year profit forecast despite warning that revenue would end up at the lower end of its previous outlook.
United Tech, with more than 218,000 employees, said some 575 employees in its Pratt & Whitney jet engine business accepted buyout offers last week, while the company has begun laying off workers at its Sikorsky helicopter unit. Similar cuts at other units may follow.
Those trims still stand to be far less severe compared with a round of layoffs in March 2009, when United Tech announced it would slash 11,600 jobs as a result of the economic downturn.
Oversupply plaguing the mining and metals industries has led to a wave of spending pullbacks. The latest to do so was mining equipment maker Caterpillar Inc, which said on Wednesday it would reduce costs after announcing a 43.5 per cent drop in quarterly profit.
Many of the industrial cuts reflect a consistently sharper focus on efficiency among large companies, analysts said, rather than a reaction to a setback.
‘The more mature the company, the more ingrained a process it is for them,’ said Daniel Holland, an analyst at Morningstar.
But industrial companies are not the only ones cutting costs. McDonald’s Corp (MCD.N) and advertising company Interpublic Group of Cos (IPG.N) pulled back spending in regions where they are seeing weakness – China and Europe, respectively. The moves illustrate how companies may be more adept at calibrating spending to meet demand.
While companies had been attuned to the need to increase efficiency, the focus sharpened after the recession, analysts said.
‘You’ve got a much more cost-conscious discipline in corporations than you did six years ago before the crisis,’ said Oliver Pursche, president of Gary Goldberg Financial Services.
The question for these companies is whether they are nearing the point that cost cuts could damage their operations.
-With New Age input
