BUSINESS

THE PROFIT PUZZLE

A JUMP IN CORPORATE EARNINGS MASKS SOME DISTURBING TRENDS

TOM FENNELL November 15 1993
BUSINESS

THE PROFIT PUZZLE

A JUMP IN CORPORATE EARNINGS MASKS SOME DISTURBING TRENDS

TOM FENNELL November 15 1993

THE PROFIT PUZZLE

BUSINESS

A JUMP IN CORPORATE EARNINGS MASKS SOME DISTURBING TRENDS

At Hamilton’s giant Dofasco Inc. steel works, the company motto is: “Our product is steel, our strength is people.” But a deep economic recession and increased global competition in the steel industry have forced Dofasco president John Mayberry to make some hard decisions. Only by restructuring, steadily reducing staff and spending massively on new equipment, he concluded, would his company survive. In fact, in 1991, during the recession, Dofasco concluded a $2-billion modernization program that had begun a decade earlier. And two weeks ago, the changes paid off when Dofasco announced a third-quarter profit of $62 million—its first since early 1991—as well as the elimination of 750 more jobs. Like Dofasco, dozens of Canadian firms,

which have had to restructure and modernize during the recession, are hoping that 1994 will bring a return to healthy profits. For the moment, though, Canada’s economy is barely growing, and a new survey shows that while third-quarter corporate profits are up, they increased only marginally. Still, Mayberry is optimistic. “We have repositioned ourselves for the year 2000,” he said.

In fact, the profit increases masked a number of disturbing economic trends. Most of the profits were generated primarily by downsizing, layoffs and asset sales. In a report released last month, the Bank of Nova Scotia concluded that industrial output is still declining in four out of 10 sectors it surveyed. And Robert Boaz, an economist with Deacon Barclays de Zoete Wedd Ltd. in Toronto, said

that the Canadian economy may be stagnating. While many of the country’s largest companies have undergone a painful restructuring and are in a position to expand, they can only do so when consumers start buying their products. Consumers, in turn, are waiting for industry to start building confidence by hiring new workers. Boaz says that if that standoff does not end soon, profits will slump in 1994 and Canada will remain mired in a painfully slow recovery. “It’s a catch-22 situation,” Boaz said. “Employers won’t employ people unless they are making money. But they are not going to make money because people are unemployed.”

The sluggish pace of the Canadian economic recovery was clearly reflected last week in a major poll of 101 Canadian companies released by Torontobased Dow Jones Canada Inc. The firms surveyed had a third-quarter combined profit of $644.1 million, but that was only 3.7 per cent higher than in the same period last year; of those firms, 73 reported improved earnings, while 28 posted worse results. Other statistics also paint a cloudy picture. The Ottawa-based Conference Board of Canada now predicts that Canada’s real gross domestic product (GDP) will grow by 2.4 per cent in 1993, down from its forecast of 2.8 per cent in August. “In a good recovery year we should see real GDP growth of 4.5 per cent,” said James Frank, the board’s vice-president and chief economist. “Even our growth projections of three per cent in 1994 may be optimistic.”

Still, there are bright spots in some sectors. The beleaguered Canadian steel industry is one. Dofasco's third-quarter profit of $62 million was up from a loss of $14.7 million a year earlier. And Stelco Inc. of Hamilton recorded a paper-thin profit of $2 million, compared with a loss of $58 million during the same period in the pre vious year. Even troubled Algoma Steel Inc. of Sault Ste. Marie, Ont., earned a slim $4.9-million profit, al though most of it resulted from asset sales. Jay Gor don, a steel analyst with the Toronto investment firm Credilinance Securities Ltd., said that if the steel indus

try is to remain healthy in 1994, the Canadian dollar will have to stay in the 75-cent (U.S.) range, exports will have to increase and the economy will have to keep growing. “If one of these conditions turns negative,” added Gordon, “we’ve got major problems.”

The mining, manufacturing and forestry sectors, traditionally the engines of economic growth in Canada, posted mixed third-quarter results. Eight mining companies in the survey, including Vancouver-based Comineo Ltd. and Inco Ltd. of Toronto, had a combined profit of $46.5 million, down 62 per cent from a year earlier. World metal and mineral prices are at their lowest levels in a decade, forcing Inco and other Canadian producers to slash production. In the forestry sector, higher lumber prices in the third quarter pushed profits to $22.4 million, up from a loss of $180.8 million during the same period last

year; but that profit was down $24.7 million from second-quarter figures this year. In the critical automobile industry, Ford Motor Co. of Canada lost $113.8 million in the third quarter of 1993, compared to a $33.6-million loss during the same period last year. However, after factoring out the Ford loss, consumer goods manufacturers in the survey reported a 15-per-cent rise in profits.

But the slim overall profit gains merely underscored what many unemployed Canadians already know—that it likely will be a long time before they share in the fruits of the recovery. In fact, Aron Gampel, assistant chief economist at the Bank of Nova Scotia in Toronto, says that the current turnaround is running well behind the pace of previous recoveries. According to Scotiabank, only half of the industries it surveyed had recorded double-digit growth this year. By contrast, after the 1982 recession, nearly every major industry grew at rates above 10 per cent. Added Gampel: “Even the industries that are growing are advancing at a much slower rate than normal.”

And the pace of the economy, most analysts say, is not likely to pick up anytime soon. Deacon Barclay’s Boaz said that before the recovery gains momentum, sales will have to increase globally. But with the economies of the United States, Europe and Japan barely growing, he said, there is little chance that Canadian profits will soon increase.

If there is a larger-than-expected upturn in the world economy, however, most economists agree that the profits of Canadian companies could take off. Neil Johnson, an economist and portfolio strategist with the Toronto investment firm Nesbitt Thomson Inc., said that because of cost cutting and restructuring, Canadian companies are now among the most productive in the world; they could boost their profits by 30 to 35 per cent in 1994, he added—if the world economy grows. And he sees some reason to be optimistic. “Exports have been running in the double-digit rates,” said Johnson.

The auto sector could be the key to generating higher Canadian profits in 1994. Dennis DesRosiers, president of DesRosiers Automotive Consultants Inc. in Toronto, said that North American automobile manufacturers have been investing heavily in modernizing their Canadian operations. Vehicle and parts manufacturers have invested more than $2.5 billion in their Canadian operations annually for the past eight years. As a result, DesRosiers says that the industry could build substantially more North American-made cars in the 1990s. That production alone could pull Canada out of its economic slump. “The auto industry is exploding with activity,” said DesRosiers. “The sector has the ability of taking the Canadian economy by the scruff of the neck and putting it on its feet again.” But consumers will have to order those cars, and, until they see signs of economic stability, profits for Canada’s major manufacturers are unlikely to climb much higher.

TOM FENNELL