Analysis: Companies offset weak sales growth with fat margins
By Scott Malone and Ben Berkowitz | January 28, 2013 12:21 AM EST
After four years of belt-tightening, American companies are good at squeezing more profit out of every dollar of sales - a skill that chief executives regard as critical in the face of an uncertain economy.
While the headline-making cuts of the last recession - when companies shed tens of thousands of workers as they scrambled to lower costs - have mostly passed, they have kept their focus on finding lots of small steps to improve earnings.
For some companies, the changes are relatively simple. McDonald's Corp
For others, pumping up the results involves a more complicated dance, keeping costs down while still spending enough on research and development to ensure they have a steady stream of new products to rely on.
Toothpaste and detergent maker Procter & Gamble Co
"You've got to do both at the same time. You have to do innovation and productivity at the same time," McDonald said in an interview.
Conglomerate Honeywell International Inc
"We want to be able to do everything right and fast," said CEO David Cote. "In a slow-growth global economy, this becomes especially important for margin rate growth."
More broadly, companies in the Standard & Poor's 500 index <.SPX> that have reported quarterly results so far this earnings season have averaged a 7.7 percent rise in profit on 5.2 percent revenue growth.
Management consultants say that is due, in part, to a renewed focus on spending to grow.
"I'm seeing organizations being very, very disciplined. They are willing to invest, but they are only willing to invest where they see tangible returns," said David Axson, a managing director in Accenture's finance and enterprise performance consulting group who works with Fortune 100-level CFOs. "Profit opportunities are very transitory at the moment.
LITTLE FAT TO TRIM
Corporate America has become far more selective in its cutting, largely because it has already become so lean.
"They have done a phenomenal job of becoming more efficient," said JJ Kinahan, chief derivatives strategist at TD Ameritrade in Omaha. "There's not a company now that can actually survive with any fat on the bones."
Honeywell's focus on margin improvement is constant and extends across most of the company - from tweaking manufacturing processes to make products with less waste, to focusing on newer products that face less competition and can command higher prices, said Chief Financial Officer Dave Anderson.
"It's not just squeezing," Anderson said in a telephone interview. "Anybody can do that on a short-term basis, but you can't sustain it."
Companies have continued to find fat to trim, though.
Lockheed Martin Corp
Diversified manufacturer 3M Co
Thulin, who took the reins at the maker of Post-It notes and film used in television screens, has identified a handful of units where he has similar concerns. He is also raising the company's research and development budget to 6 percent of sales this year from 5.5 percent in 2012.
One analyst said companies need to cut costs, but also need to ensure they are cutting the right ones and not expenses such as research and development that will lead to future growth.
"There is a generation of managers out there that experienced the recession, understand what the ramifications are of carrying too much cost into one of these cycles and, as a result, are very focused on margins," said Daniel Holland, equity analyst at Morningstar in Chicago, who covers big industrial companies. "That's a mark of management post the recession."
The continued success of companies has boosted investor confidence and helped send the S&P 500 up almost 5 percent since the start of the year. Investors had been very conservative about their expectations for earnings growth because of such things as wrangling in Washington over the "fiscal cliff" of drastic tax increases and budget cuts.
"The bar was so low and that was because of things that happened in the fourth quarter, particularly Hurricane Sandy and its impact, and the fiscal cliff impact, and I think things are not turning out as bad as analysts anticipated," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont.
"You're seeing some individual stocks get hammered because expectations were unrealistic and you're seeing other stocks rally because expectations were set much too low."
Amid all the cost-cutting, there is also a sense among some companies that the situation in Europe is not as dire as it had been, an added bonus in year-end results.
Of course, there are still problems: Top U.S. auto parts supplier Johnson Controls Inc
But for others, it is clear that Europe is, at a minimum, less of a headache.
"We have seen signs of stabilization, particularly in Europe," said Greg Hayes, chief financial officer at United Technologies Corp
China, meanwhile, was a big boost for many companies. 3M notched its best quarter in a year in China, reporting 16 percent growth in organic sales. P&G reported "high single digit" percentage growth and Starbucks Corp
However, be it cutting costs, or restructuring operations, or any other means in the executive tool kit, the laser focus on margins reflects CEOs who remain wary of the economy souring again.
"I see very little downside in being prepared for the downside," Honeywell's Cote added.
(Additional reporting by Jessica Wohl in Chicago and Caroline Valetkevitch in New York; Editing by Andre Grenon)
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