Overstored?

By: Chad Hudson | Wed, May 2, 2001
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The flurry of corporate earning releases is winding down. Industrial companies concentrated their statements to three over-riding themes. Companies were generally “cautiously optimistic.” They saw some signs of recovery but were not comfortable saying the recovery is a sure bet. Cost cutting is paramount. Companies are focusing their energy on reducing their cost structure so profitability will be enhanced when the recovery gains traction. Lastly, capital expenditures are getting slashed. Companies spent too much during the late 90’s and realize it now. Oh yeah, and revenues are lower.

Companies selling to consumers are doing much better, with several posting record results such as the homebuilders. No doubt the booming real estate market helped Sears’ home appliance segment post strong single digit gains. Coach, the maker of leather goods, increased revenues 29% in is third quarter and earnings by 88%. While Marriott’s lodging revenues fell 7%, timeshare sales were up 11%. Clearly the consumer has not retrenched.

With companies continuing to focus on reducing costs, it is likely that layoffs will continue. Tyco announced today that it will layoff 7,100 workers. Plus, one company’s expense is another company’s revenue. As companies continue to cut costs, other companies will be forced to pare down operations as well. This week Unisys and the Business Travel Coalition released the results of a joint sponsored survey of businesses that spend heavily on air travel. It found that 60% of respondents will cut travel budgets, and 74-75%% of those plan to make some portion permanent. This will not only affect the airlines but car rentals, hotels, and restaurants.

Aggressive accounting dominated financial statements during the 1990’s. Aggressive accounting helped companies report stellar earnings gains and helped perpetuate the stock market bubble. Now it will be difficult for companies to cut costs. One example is in capital expenditures. When companies purchase capital infrastructure the cost is typically capitalized and depreciated over several years. Since earnings are derived from subtracting deprecation and not the actually expense when incurred, cuts in capital expenditures will not have a dramatic affect on the bottom line. However, since investors are looking past the pro forma income statements and finding the statement of cash flows, this should help instill confidence in the company. But again one company’s expense is another company’s revenue. Investors will have to watch out for companies that are dependant on maintenance capital expenditure and make sure they are not reduced. Companies that cut back on maintenance could suffer longer term consequences.

Anyone who has read a newspaper or watched any business news show on television knows that telecom is in horrible shape. Nortel, one of the biggest suppliers of telecom equipment, saw its revenues fall 49% year-over-year, and 16% sequentially to $2.9 billion. First quarter revenue is below 1997 levels and is 11.5% higher than first quarter 1996. Nortel commented, “The market size shrunk noticeably from what was expected.”

Companies are being very cautious about spending. During Nortel’s conference call Frank Dunn, president and CEO, said:

“I've been traveling around the world and the feedback I'm getting is that people will not spend any money without being thoughtful. Many of them are saying they will spend a dollar in capital as long as you can cut down op ex by two or three dollars. Some of them are talking about how to drive data services. So in my mind it's all about taking existing capital and redistributing it. I don't know when it will change. The good news is we're more engaged in planning than five / six months ago. I have more certainty of my outlook this quarter than I did last time in this quarter. I don't expect to see a robust activity in the next three or six months.”

NT’s capital expenditure was just over $100mm and expects 4-600mm for the year. Last year Nortel spent $1.3 billion on capital expenditure and almost $1.9 billion in 1999.

Molex is also in the telecom sector. It was not optimistic about the future of its capital spending. Molex reduced its capital spending plans to about 10% of revenues. Historically, Molex had spent about 15% of its revenues on capital spending. Molex said it spent a tremendous amount of capital over the past 2-3 years, and it has more than enough general purpose capacity. Molex said “Aggregate capital expenditures should remain at reduced levels through our fiscal year ending June 30, 2003.” That is, it believes that it will maintain the same position next year because they have more than enough capacity. Molex also said that customers “are happy to give us forecasts but are not happy to make any commitments based on those forecasts.” Hopefully employees were not listening to the conference call. Molex said in order to reduce costs it does not plan on paying bonuses this year.

Companies that are spending money are much more cautious and are actually frugal. Briggs & Stratton increased its revenue by 9% in the first quarter compared to last year. The “9% increase was primarily the result of a 14% increase in number of units sold offset by a sales mix of engines weighted toward lower priced units.” The company thinks the trend of lower priced engines will persist, “We believe we will not only have an engine sales mix that favors lower horsepower, lower priced engines, but a continuation of the trend we saw through nine months to purchases engines that are lower priced because they have fewer features.”

Revenues for Yellow Transportation fell 10% in the first quarter compared to last year. Total tonnage was down 7.4%. Yellow did say that each month got better during the first quarter. Arkansas Best reported similar results with volume in its shorter haul lanes decreasing 5.1% and the longer haul business down 7.5%. However, president and CEO, Robert Young offered a much different picture on the trend of business. “Every day I hear that the recession is over and economic expansion has begun. So far, this has not been reflected in the amount of freight that is moving on our trucks.”

Honeywell and Ingersoll-Rand provided examples of how important cost cutting is.

Honeywell, “While we began to see signs of improvement in parts of the company in March, we are not as yet experiencing robust economic recovery across the board. The eventual pace of that recovery is still difficult to predict…We continue to reduce cost structure…”

Ingersoll-Rand, “first quarter order rates were down approximately 2% compared to last year for the total company. We are continuing to focus of permanent reductions in our internal cost structure…”

Standard & Poor’s is owned by McGraw-Hill, which details where strength and weakness is in their markets. Should be no surprise that there was, “solid growth coming from commercial mortgage-backed securities, residential mortgage-backed securities and from the collateralization of credit card and auto loans in the asset-backed market.” Corporate bond issuances declined 22.2% in the first quarter compared to last year, while mortgage-backed volume increased 35%.

Companies are focusing on the bottom line. Realizing that they overspent and bloated their corporate structure, companies are slashing costs. This will help earnings, however valuations remain extremely rich. Investors in “old economy” stocks have bid up stock prices to levels higher than a year ago even though results are below year ago levels. Even if the recovery is sustainable, current valuations are discounting a return back to the boom times. The rest of the year will be an interesting tug-of-war between the bulls and the bears. Both camps have data that support their case, but the bull are being short-sighted.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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