Transcript Document

Outlook for Corporate Profits
Which are the Leading Sectors?
Mark Killion, CFA
Managing Director
August 2003
Copyright ©2003 Global Insight, Inc.
Outlook for U.S. & European Corporate Profits
Agenda:
 Corporate profits are key to:


Understanding asset valuation, credit quality
Anticipating the CapEx cycle and employment growth
 Corporate GAAP net income is more volatile than NIA
operating profits

What have been the recent trends in each?
 ROE framework to analyze future prospects for profits

Impact of operating leverage and financial efficiency
 Which sectors are winners and losers?
Copyright ©2003 Global Insight, Inc.
2
Two Measures of U.S. Corporate Profits
40
35
30
25
20
15
10
5
0
2002
2003 E
2004 E
45
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
50
U.S. Domestic Corporate Profits, US$ Billions
1100
Corporate GAAP profits (filed with
1000
SEC) are more volatile than
Profits as S&P 500 GAAP (EPS, LHS)
NIPA operating profits (filed
900
with IRS and used by BEA),
largely due to:
800
--Balance Sheet Impacts
700
--Regulatory Changes
600
Recent examples:
500

2000—Goodwill write-offs
and decline in credit quality
400

2001—Corporate fraud, asset
300
impairment, bankruptcy, and
bad loans
200

2002—Expensing stock
Profits as NIPA (Bill.$, RHS)
100
options, CEO certification,
and E&O insurance
0

2003—Year of pension
expense adjustment, change
in executive compensation
structure, and dividend
Profits as S&P 500 GAAP from SEC (EPS, LHS)
taxation
Profits as NIPA from IRS via BEA (Bill.$, RHS)
1985
1986
1987
S&P 500 US$ Earnings Per Share
55
Copyright ©2003 Global Insight, Inc.
Source: Standard & Poor’s, U.S. BEA, GII Forecasts
3
How Are U.S. Profits Faring in the Business Cycle?
The Adjustment for Capital Consumption Has
Become Unreliable
How Does the Current Profit Recession Compare to the
Previous Profits Recession of 1988-92?
140
130
120
110
97Q4-03Q1
with CCA
Adj.
100
90
80
70
Adjustment in Bill. US$
Index 100 = Cycle Peak
88Q4-94Q1 with CCA Adj.
14 0
35
12 0
30
10 0
25
80
20
60
15
40
10
20
5
0
0
97Q4-03Q1 -- No CCA Adj.
60
-7 -5 -3 -1 1
3 5
7 9 11 13 15 17 19 21
Index for 1988 Q4 to 1994 Q1
C C A A djus t m e nt in US $ ( LH S )
Index for 1997 Q4 to 2003 Q1
1997 Q4 to 2003 Q1--No CCA Adjustment
C C A A djus t m e nt a s % o f B a s e ( R H S )
Copyright ©2003 Global Insight, Inc.
Source: U.S. BEA
4
Adjustment as % of Profits
(CCA Adjustment from Tax-based to Economic Depreciation Rates Where a
Positive Number indicates a Boost to NIA Corporate Profits, by Taking Back Some
Tax-based Depreciation Claimed Against Profits)
U.S. Corporate Profits in Quarters After Cycle Peaks (88-92 vs. 97-03)
(Index = 100 at Cycles Peak of Corporate Profits: 1988 Q4 and 1997 Q4)
Which U.S. Sectors Are Generating Profits?
Sectors with Positive and Steady Profits
Sectors with Positive and Improving Profits
(Billions of US$)
(Billions of US$)
250
250
200
200
150
150
Wholesale Trade
Food & Related Products
Financial NonBanking
Electricity & Utilities
100
50
50
0
0
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV
I
Annual
Receipts from Rest of World
100
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV I
Last 8 Quarters
Copyright ©2003 Global Insight, Inc.
Annual
Last 8 Quarters
Source: U.S. BEA
5
Which U.S. Sectors Are Recovering or Stalling?
Sectors Where Past Losses are Turning into
Profits Recovery
Sectors With Steady Profits Now Under
Moderate Pressure
(Billions of US$)
(Billions of US$)
25
Electronic & Electrical
Steel & Metals
Transportation Services
20
100
90
80
70
15
10
60
Banking (In Federal Reserve System)
50
Retail Trade
40
5
30
0
-5
-10
20
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV
I
10
0
Annual
Last 8 Quarters
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV I
Annual
Copyright ©2003 Global Insight, Inc.
Last 8 Quarters
Source: U.S. BEA
6
Which U.S. Sectors Are Generating Profits?
Sectors With No Recovery Yet in Profits
Sectors with Exposure to Oil Related Factors
(Billions of US$)
(Billions of US$)
40
Industrial Machinery & Equip.
Motor Vehicals & Parts
Communication Services
30
40
Petroleum & Coal Products
35
Chemicals & Products
30
25
20
20
10
15
10
0
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV
I
-10
-20
5
0
Annual
Last 8 Quarters
1995 1996 1997 1998 1999 2000 2001- 2001- 2001- 2002- 2002- 2002- 2002- 2003II
III IV
I
II
III IV
I
Annual
Copyright ©2003 Global Insight, Inc.
Last 8 Quarters
Source: U.S. BEA
7
Which U.S. Sectors Are Generating Profit
Growth?
One-year Historical $EPS Growth for U.S. Sectors
Ranked by Fastest to Slowest EPS Growth
(Latest 4 Quarter EPS Dollar Increase over Previous 4 Quarters: Q2 2002 -- Q1 2003 EPS as $ Increase/Decrease over Q2 2001 -- Q1 2002 EPS )
Information Technology
Telecommunication Services
Financials
Consumers Staples
Health Care
-$1.54
$1.35
$19.94
$11.5
$13.54
Industrials
$8.27
Materials
$1.9
Energy
$8.35
Utilites
$2.32
-10
-8
-6
-4
-2
0
2
4
6
8
10
Dollar Change in EPS in S&P 500 -- Most Recent 4 Quarters Sum (Ending in 2003Q1) Over
Previous 4 Quarters -- Numbers Shown on LHS are Total $EPS of 2002Q2 -- 2003Q1
Copyright ©2003 Global Insight, Inc.
Source: Standard & Poor’s
8
Compare the Latest Profits Trends in the U.S. to the U.K.
United States
United Kingdom
Corporate Profits Growth Rate (LHS) and
Profits as Shares of GDP (RHS)
Corporate Profits Growth Rate (LHS) and
Profits as Shares of GDP (RHS)
(Percent)
(Percent)
24
20
14 20
26
17
25
14
24
11
23
8
22
5
21
2
20
12
16
10
12
8
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
2004 E
2
1988
-1
1987
4
2003 E
-8
2004 E
2002
-4
2003 E
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
0
6
1986
4
1985
8
-4
18
US NIA Corporate Profits Growth (LHS)
UK NIA Corporate Profits Growth (LHS)
US Corporate Profits Share of GDP (RHS)
UK Corporate Profits Share of GDP (RHS)
Copyright ©2003 Global Insight, Inc.
19
Source: GII World Economic Service
9
What Are the Latest Trends in European Profits?
Compare Germany to France
Germany
France
Corporate Profits Growth Rate (LHS) and
Profits as Shares of GDP (RHS)
Corporate Profits Growth Rate (LHS) and
Profits as Shares of GDP (RHS)
(Percent)
(Percent)
15
14
Germany NIA Corporate Profits Growth (LHS)
France NIA Corporate Profits Growth (LHS)
Germany Corporate Profits Share of GDP (RHS)
France Corporate Profits Share of GDP (RHS)
Copyright ©2003 Global Insight, Inc.
2004 E
2002
2003 E
2001
2000
1999
1998
1997
1996
-4
1995
14
-4
1994
-1
1993
15
-1
1992
16
1991
2
1990
16
1989
2
1988
17
1987
5
1986
17
1985
5
2004 E
18
2002
8
2003 E
18
2001
8
2000
19
1999
11
1998
19
1997
11
1996
20
1995
14
1994
20
1993
14
1992
21
1991
17
1990
21
1989
17
1988
22
1987
20
1986
22
1985
20
Source: GII World Economic Service
10
Return On Equity (ROE) as Measure of Profitability
“DuPont System” ROE framework shows the rate of return that
management earns on capital provided by the shareholders
(Profits calculated relative to the equity interest, after accounting for payments to all other capital suppliers)
DuPont Ratio Interpretation:
ROE Framework Identity:
ROE is always described by some combination of:
Return on Equity (NI/Equity) =
profit margins, reflecting efficiency in production, the mixture
of fixed versus variable cost, and/or the presence of pricing power
Profit Margin (NI/Sales) *
asset turnover, showing the degree to which company assets
are generating sales
Asset Turnover (Sales/Assets) *
financial leverage, showing the extent to which the asset base
Financial Leverage (Asset/Equity)
is financed by debt
Where: NI = Net Income; Equity = Book Value of
Equity, Valued at the End of the Preceding Period;
Assets Are Total Current Period; Sales Are Gross;
( * Denotes a multiplication sign)
In this framework, the component “DuPont” ratios
outline the relationship that profits have with sales,
pricing power, balance sheets, and industry structure.
Copyright ©2003 Global Insight, Inc.
Source: Investment Analysis and Portfolio Management,
By Frank K. Reilly & Keith C . Brown
11
South-Western, Nov. 2002.
Return On Equity shows rate of return that management
earns on capital provided by the shareholders.
What Has Been the Return on Equity
Performance in the United States?
U.S. Corporate Return on Equity
Total for 1,500 U.S. Corporations in the
GICS Sector Classification Scheme
ROE in %
Component Ratios
12
20
18
10
16
14
8
12
10
U.S. posted excellent ROE record through 1997:
Problem of falling asset efficiency, related to M&A purchases
and CapEx spending
Largely offset by production efficiency and rising margins
Increase in operating leverage
6
Pressures on margins built up from mid-1990s:
8
4
6
4
2
Compression from Asian / Russian crises in 1998
Increase in financial leverage to compensate
0
What happened in 2001-02?
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0
1991
2
High operating leverage killed margins when growth slowed
Deteriorating credit quality and corporate malfeasance
Markets forcing a de-leveraging of balance sheets
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
12
Return On Equity for European Listed Companies
Continental Europe
Corporate Return on Equity
United Kingdom
Corporate Return on Equity
Total for 500 Corporations in the GICS
Sector Classification Scheme
Total for 300 Corporations in the GICS
Sector Classification Scheme
Component Ratios
ROE in %
20
12
18
ROE in %
Component Ratios
20
12
18
10
16
14
8
12
10
16
14
8
12
10
6
8
10
6
8
4
6
4
6
4
2
2
4
2
2
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
2001
2000
1999
1998
1997
1996
1995
1994
0
1993
0
1991
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0
1992
0
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
13
What Is the Sector ROE Performance?
Five-year Historical ROE for U.S. and Continental European Sectors
Ranked by European Perspective – Largest to Smallest
(Average ROE for U.S. & European Sectors—excl. U.K.—Average over 1998-2002, Top 10 GICS Economic Sectors)
Consumer Staples
Energy
Health Care
Financials
Utilities
Materials
Industrials
Total
Information Technology
Consumer Discretionary
Telecommunication Svs.
0
5
10
15
United States
Copyright ©2003 Global Insight, Inc.
20
25
Europe
Source: Worldscope Company Financial Statements &
GII Calculations
14
Sector Level Return On Equity—Health Care
Comparison of Europe and United States
European Health Care
U.S. Health Care
Total for all European (excl. U.K.)
Corporations in the Health Care GICS
Sector
Total for All U.S. Corporations in the
Health Care GICS Sector
ROE in %
Component Ratios
ROE in %
Component Ratios
30
15
30
15
25
12
25
12
20
20
9
9
15
15
6
6
10
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
2002
2001
2000
1999
1998
1997
1996
0
1995
0
1994
0
3
1993
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0
5
1992
3
5
1991
10
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
15
Sector Level Return On Equity—Telecommunications
Comparison of Europe and United States
ROE for U.S. Telecommunication Services
ROE for European Telecommunication Services
Total for All U.S. Corporations in the
Telecommunications GICS Sector
Total for all European (excl. U.K.) Corporations in the
Telecommunications GICS Sector
ROE in %
Component Ratios
20
15
10
15
ROE in %
Component Ratios
20
15
15
10
5
10
5
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-10
2002
2001
2000
1999
1998
1997
1996
1995
-5
1994
-5
0
1993
5
-5
1992
0
1991
10
0
0
5
-10
-15
-10
-20
-15
-25
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
16
Sector Level Return On Equity shows a tale of two
different U.S. consumer sectors
ROE for U.S. Consumer Staples
ROE for U.S. Consumer Discretionary
Total for all U.S. Corporations in the
Consumer Staples GICS Sector
Total for all U.S. Corporations in the Consumer
Discretionary GICS Sector
ROE in %
Component Ratios
ROE in %
Component Ratios
30
15
30
15
25
12
25
12
20
9
15
20
9
15
6
10
6
10
2002
2001
2000
1999
1998
1997
1996
1995
0
1994
0
1993
3
1992
5
1991
2002
2001
2000
1999
1998
1997
1996
1995
1994
0
1993
0
1992
3
1991
5
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
17
Sector Level Return On Equity shows a tale of two
different European consumer sectors
ROE for European Consumer Discretionary
ROE for European Consumer Staples
Total for all European (excl. U.K.) Corporations in the
Consumer Discretionary GICS Sector
Total for all European (excl. U.K.) Corporations
in the Consumer Staples GICS Sector
ROE in %
Component Ratios
30
15
25
ROE in %
Component Ratios
30
15
25
10
20
15
20
10
15
5
10
10
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
0
2002
2001
2000
1999
1998
1997
1996
1995
-5
1994
0
1993
5
1992
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-5
1991
0
0
1991
5
5
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements
18
How Will Corporate ROE Rise from Here?
 Improvement in profit margins remains the most likely source of
near-term earnings growth:



Interaction among operating leverage, capacity utilization, and profit margins
Some operating cost reductions already achieved
Many sectors will need growth in CapEx to generate high margins
 Financial restructuring has been in vogue, but will markets allow
for additional debt?



CapEx increasingly funded with retained earnings
Return on investment receives greater scrutiny by investors
Raising the profile of net income relative to current operating profits
 Asset turnover is at low point, there is room to rise, but longterm trend is down



Already quite a lot has been accomplished in asset repricing, adjustments for
credit quality, and impairment write-offs
Some sectors showing recent pickup in asset turnover
Any sizeable increase in M&A and CapEx will limit room for improvement in
asset efficiency
Copyright ©2003 Global Insight, Inc.
Source: GII World Industry Service
19
Will Profit Margins Rise in Key Growth Sectors?
Technology and Financial Sectors in U.S. and Europe
Operating Profit Margins (Excludes Depreciation and Write-offs)
(Comparison between U.S., U.K., and Continental Europe)
Operating Profit Margin for All
Companies in the Technology Sector
20
Operating Profit Margin for All
Companies in the Financial Sector in
in the GICS Classification Scheme
15
15
10
10
5
5
0
0
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
-5
United States
United Kingdom
Europe (X UK)
the GICS Classification Scheme
20
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
-5
Copyright ©2003 Global Insight, Inc.
United States
United Kingdom
Europe (X UK)
Source: Worldscope Company Financial Statements
20
How Do Sector Profits Change with Sales Growth?
Degree of Operating Leverage
Sector Beta Relating Operating Profits to Sector Sales Growth, Where a Number Above 1
Shows Higher Leverage, Below 1 Shows Lower Leverage (1990-2002)
2.5
2
1.5
1
Copyright ©2003 Global Insight, Inc.
Source: GII World Industry Service
Banking &
Insurance
0
Wholesale &
Retail
0.5
Comm Svs.
0.71
0.80
0.86
1.07
1.10
1.33
1.71
World Exc. US
3
All Services
Industrial Chemicals
Medical Technology
Communication Services
Wholesale & Retail Trade
Drugs & Medicine
Banking & Insurance
Motor Vehicles
US
3.5
Motor Vehicles
Sector DOLs for World Total:
4
Drugs &
Medicines

4.5
Industrial
Chemicals

Degree of Operational Leverage (DOL)
summarizes how changes in sales growth
affect profits growth
DOL reflects mix of fixed costs versus
variable costs in business operations
Sectors with high fixed costs and/or big
CapEx needs often have higher DOL
All Goods

21
How Much Financial Leverage Will Markets Allow?
Measures of Financial Leverage
(Financial Multiplier, Gearing Ratio, and Interest Expense Ratio)
U.S. Totals for All Non-financial
European Totals for All Non-financial
Corporations in the GICS Sector
Classification Scheme
Corporations in the GICS Sector
Classification Scheme
5
1.5
5
4.5
4.5
4
4
3.5
1
3.5
3
3
2.5
2.5
2
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
0.5
1.5
2
Interest Expense as % of Total Expense
Financial Leverage Ratio (Asset/Equity)
Ratio of Debt to Equity (RHS)
Copyright ©2003 Global Insight, Inc.
1
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
0.5
Interest Expense as % of Total Expense
Financial Leverage Ratio (Asset/Equity)
Ratio of Debt to Equity (RHS)
Source: Worldscope Company Financial Statements
22
Sector Level Return On Equity—Industrials
Sector Level Example of the Use of Financial Leverage
European Industrials Sector
Total for all European (excl. U.K.) Corporations in the Industrials GICS Sector
Return On Equity
Measures of Financial Leverage
ROE in %
Component Ratios
6
8
4
6
3
4
2
2
1
0
0
2002
5
2001
10
2000
6
1999
12
1998
7
1997
14
1996
8
1995
16
1994
9
1993
18
1992
10
1991
20
1.5
5
4
3
1
2
1
0
0.5
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
Interest Expense as % of Total Expense
Financial Leverage Ratio (Asset/Equity)
Ratio of Debt to Equity (RHS)
ROE (%) LHS
Margin (%) RHS
Financial Leverage (Ratio) RHS
Asset Turnover (Ratio*10) RHS
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements &
GII Calculations
23
Which U.S. Sectors Have the Highest Gearing Ratio
(Debt to Equity)?
U.S. Sector “Saints” and “Sinners” with Financial Leverage
(Gearing Ratio: Ratio of Debt to Equity)
Sectors with Steady/Declines in D/E Ratio
Sectors with High/Buildup in D/E Ratio
2
2
1.5
1.5
1
1
0.5
0.5
0
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
0
Industrials
Telecomm--Wireless
Utilities
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
Consumer Staples
Energy
Health Care
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements &
GII Calculations
24
Which European Sectors have the Highest Gearing
Ratio (Debt to Equity)?
European Sector “Saints” and “Sinners” with Financial Leverage
(Gearing Ratio: Ratio of Debt to Equity)
Sectors with Buildup in D/E Ratio
Sectors with Declines in D/E Ratio
2
2
1.5
1.5
1
1
0.5
0.5
0
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
0
Industrials
Consumer Discretionary
Utilities
'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02
Telecommunications
Energy
Materials
Copyright ©2003 Global Insight, Inc.
Source: Worldscope Company Financial Statements &
GII Calculations
25
Rank of U.S. & European Sector Profits Growth
Long-term “Normalized” Sector Profits Growth
(Average Percent Growth of Operating Profits, Forecast for 2004-08, Top 10 GICS Economic Sectors)
Technology
Health Care
Financial
Telecomm's
Industrials
Total
Cons. Discretionary
Utilities
Consumer Staples
Materials
Energy
0
1
2
3
United States in US$
Copyright ©2003 Global Insight, Inc.
4
5
6
7
Europe in Euros
Source: GII World Industry Service
26
Thank you!
Mark Killion, CFA
Managing Director
World Industry Services
Global Insight, Inc.
Phone: 610-490-2547
email: [email protected]
Copyright ©2003 Global Insight, Inc.
27