Money
Issue No. 12 - August/September 2003
Profits — a Sustainable Recovery?
by Tony Catt
In the last few months the profit debate appears to have subtly shifted from the existence of a profit recovery, to its sustainability. While profits in the first quarter of 2003 grew 15% year—on—year, bears argue the recent strength of profit growth is ‘one off’ in the sense that it has been driven primarily by cost reductions.
Our relatively bullish view of profitability continues to be based on the positive (and sustainable) trends in productivity that have unfolded since the end of the bull market, combined with a moderate pick up in top line growth. US dollar weakness is only adding to our positive profit view. In May we upgraded our US 2003 eps estimates from 50c to 52c due to the impact of US$ depreciation—a growth rate of 13% on 2002 calendar year.
The prevailing bearish view on profitability suggests that profit growth will be sub—par due to a over—capacity and weak demand from both a consumer and business investment perspective. However, historical analysis demonstrates that the existence of excess capacity has not been a barrier to a profit growth pick—up.
What is potentially different about this particular profit cycle is the lack of pent—up consumer demand, which will act to limit economic growth and profit upside. However, we believe that pent—up business demand will drive an economic and profit acceleration in coming quarters. The key will be whether business demand can accelerate in combination with ‘reasonable’ consumer demand growth.
A number of factors should support the investment and profit backdrop.
Historical analysis for the US shows that profit margins improve during the early stages of recovery, regardless of excess capacity. This initial increase tends to be driven by labour productivity gains rather than rising pricing power (as we have witnessed over the past year). The direction of excess capacity trends is more important than the absolute level. The existence of some spare...
