Thursday, July 27, 2017

Recession Avoided or Merely Delayed?


No, Virginia, Earnings Week isn't another one of Donald Trump's "theme weeks".


Earnings are coming out this week, and analysts are surprised that earnings are higher than expected for many companies.   Does this mean the signs of downturn in the economy are overstated?   Is a recession avoided?   Or merely delayed.

Take Ford, for example, which beat analysts' expectations despite 16% drop in sales.   Ford isn't making more profits, but less.   By taking advantage of foreign tax credits for years of losses overseas, Ford cut its tax bill in half, which propped-up earnings.

The problem is, of course, this is a one-time deal, and you can't make profits out of losses.   The fact remains, Ford's sales - and that of the entire auto industry - are down across the board.  Even pickups and SUVs are only moving out the door with generous incentives - which translates into lower profits.

A lot of other companies are reporting similar results - beating low expectations, but often because of one-time charges, cost-cutting, store closings, sale of assets, and the like.   And this is a pattern I've seen before.  When sales drop off and markets go South, companies start aggressively trimming their sails.   Cost-cutting becomes the order of the day when the sales boom dies.  People are laid off, suppliers are squeezed on prices.

Boeing, for example, also reported earnings that exceeded analysts' expectations, sending the stock soaring 8%.   Boeing has done well in the last few quarters, but are they out of the woods yet?  One reason profits are up is that capital expenditures are down.   They just finished building the new wing assembly line in South Carolina, so capital expenditures are no longer needed.   Despite this, demand for the 777 has slowed, and Boeing plans layoffs.

This does not mean, of course, that this level of profitability is here to stay.  New capital expenditures will be needed down the road - in fact, almost continuously in the airplane business.   This is less about record profits than taking a breath between plane generations.

With a backlog of orders for the 737-MAX plane, which is in dire competition with the new Airbus A320 NEO, Boeing can crank out airplanes without spending too much money on R&D and capital expenditures.  But does that mean long-term profitability?   Perhaps - they will have to spend an inordinate amount of money on the next generation aircraft, as Airbus nips at their heels.  Meanwhile sales of the aging 747 have slowed to a halt.  After decades of losses, the Dreamliner finally appears to be making money for Boeing - illustrating the tremendous risk involved in building a new aircraft, as well as the large amount of time needed to recoup costs.

So this is all good news, but only for the short-term.   Ford can't keep making money through foreign tax credits.  Sometime, it will have to sell cars and trucks at a profit - which it will, just not at as fast a clip as in the last eight years.   And soon, Boeing is going to have to go back to hemorrhaging cash to develop a radically new plane - the so-called 797 with its oval cross-section fuselage.  And Boeing has to do this, before Airbus does.

Across the board, we seem to be seeing the same thing.  I am hearing earnings reports that are better than expected, but always with this asterisk next to the numbers, explaining some one-time charge, sell off, or whatever.  These are great numbers, but what happens next quarter or next year when these asterisks disappear?

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