As Economy Gains Strength, Companies Sell (and Spend) More

By Theo Francis Features Dow Jones Newswires

Sales at large U.S. companies are growing at a clip rarely seen over the past five years, driven by an improving global economy, U.S. consumer spending and increased capital investment.

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Profits, too, are healthy at S&P 500 firms, though they aren't rising as quickly as they did earlier in the year. Earnings growth was pinched in the third quarter by higher materials and labor costs, as well as the impact of three major hurricanes on insurers.

Strong profits, labor markets and U.S. economic output, along with expectations for lower corporate tax rates, have helped power gains in the equities markets, leading the S&P 500 index to a roughly 15% surge so far this year.

But some investors say the improved global growth could have an unintended side effect: rising costs that keep profit increases in check.

"Profit margins may be in the process of topping out," said Jim Russell, a portfolio manager at Bahl & Gaynor in Cincinnati. "In fact, there's pretty good evidence that they probably are."

Per-share earnings for companies in the S&P 500 are on track to rise 8% over the third quarter last year, according to data from Thomson Reuters, led by outsized gains in the energy patch and at technology giants like Apple Inc. and Alphabe Inc. But that is a step down from the 15% and 12% growth rates posted in the first two quarters of the year.

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Excluding the energy sector, which is still rebounding from a painful contraction, S&P 500 earnings are expected to rise 5.6% -- well below a median of about 8% since 2011, Thomson Reuters data show. Estimates reflect actual results for the 80% or so of companies that have reported earnings and analyst estimates for the rest.

The insurance industry dragged on results in the third quarter as significant claims from three major hurricanes pushed profits down 61%. Excluding insurers, S&P 500 earnings are expected to rise 10.8%.

Revenues are expected to rise 5.2%, the second-best showing in six years and handily outpacing a median increase of 3.6% since the height of the financial crisis, Thomson Reuters data show.

"The revenue numbers we are seeing now are stronger than we have seen going back to 2011 or 2012," said John Butters, senior earnings analyst at FactSet.

A key driver: global growth, including improvements in Europe, which had struggled to recover from sovereign-debt and banking crises.

In the third quarter, S&P 500 companies generating at least half their revenue outside the U.S. posted earnings growth nearly six times that of companies with mostly U.S. sales, according to an analysis by Mr. Butters. Similarly, revenue grew more than twice as fast at companies generating mostly non-U.S. sales.

Several companies reported a general improvement in European demand. Snack-food giant Mondelez International Inc. cited stronger European sales, including of chocolate in Europe and Oreos and other cookies in the U.K. and Germany, as a significant driver of overall sales growth.

"Europe feels pretty good. It's about 40% of our revenue, and it's solid and stable and growing," Brian Gladden, Mondelez's finance chief, told investors on Oct. 30.

U.S. consumer spending remains healthy too, as does sentiment. A widely tracked measure of current consumer sentiment rose in October to its highest level in nearly 17 years, pushed by Americans' favorable view of the job market.

"The U.S. consumer continues to feel positive about future prospects for their personal finances and employment," David Nelms, chief executive of Discover Financial Services, told investors in late October.

But the stronger global economy also is pushing up costs for many companies -- from fuel and commodities to labor -- restraining the degree to which companies can generate higher profits on improved sales.

Both Southwest Airlines Co. and American Airlines Group Inc. said rising fuel and labor costs partly offset stable pricing and solid demand for leisure and business travel. American Airlines executives said they expect fuel prices to continue to rise in the fourth quarter, but expressed optimism that the airline could raise prices.

"We're big consumers of fuel, so fuel spikes could have an impact," American CEO Doug Parker told investors on Oct. 26. "But if it's just increases, given where we are, I think what you'd see is fares rise to levels that offset much of the fuel price increase."

Globally, crude oil prices reached about $60 a barrel, close to a 52-week high and up about $15 since June, while U.S. prices remained about $54, thanks to higher inventories in the U.S.

Companies reported other commodity price increases as well. Packaging Corp. of America, which makes a variety of cardboard for boxes, said it expects energy, wood and some key chemical costs to rise, along with freight shipping and energy costs.

Packaging Corp. also cited higher labor costs in the latest quarter. Martin Marietta Materials Inc., a gravel and sand supplier, said tight labor markets have led to project delays and are limiting significant increases in construction activity.

But overall, economist say rising labor costs alone aren't cause for worry, thanks to an uptick in productivity in the U.S. The cost of labor relative to goods and services produced is edging up, but slowly.

"What you really care about is cost per widget," said Kathy Bostjancic, chief financial economist for Oxford Economics. "Even if your cost is going up, if you're producing more widgets, that's fine."

Write to Theo Francis at theo.francis@wsj.com

(END) Dow Jones Newswires

November 03, 2017 18:30 ET (22:30 GMT)