Profits Jump, Spending Lags -- WSJ

The largest U.S. companies are booking their strongest quarterly profits in five years, as firms reap the benefits of years of belt tightening and finally see a pickup in demand. But part of the improvement has come from keeping a lid on spending, and many CEOs remain reluctant to change and open their wallets for new projects, plants and people.

Profits at S&P 500 companies jumped an estimated 13.9% in the first quarter, growing nearly twice as fast as revenue. The gains stretched across industries, from Wall Street's banks to Silicon Valley's web giants, and were helped by a rebound in the battered energy sector. The picture was a marked improvement from a year ago, when profits fell 5%, and was the best performance since the third quarter of 2011.

"We continue to focus on driving savings where possible, taking a zero-based approach to capex and capital spending," James Saccaro, chief financial officer of medical products firm Baxter International Inc., told investors last week. Zero-based budgeting means starting a spending plan from scratch each period, justifying every dollar rather than adjusting the amount spent previously.

Years of slow economic growth have trained companies to be lean, something that amplifies earnings when the top line finally does pick up. Heavy-equipment maker Caterpillar Inc. reported its first quarterly sales increase since 2015, with revenue rising about 4%, but doubled its profit, excluding restructuring costs.

"It's the perfect storm in a positive sense for earnings," said Jim Russell, portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati. For example, a company cutting costs to maintain profit in the face of slower orders or sales would benefit drastically from a turnaround without having to invest immediately.

Excluding the energy sector, which surged after more than a year of punishment from low crude prices, S&P 500 quarterly earnings rose 10% in the first quarter from a year ago, when earnings were up 0.4% on the same basis, according to Thomson Reuters. Revenue climbed 5.3% from a year ago.

The calculation excludes write-downs, restructurings and other items considered unusual. It is based on actual results from two-thirds of the S&P 500 and analyst expectations for the rest.

Data on capital expenditures suggest companies remain cautious. An analysis of results from 215 companies in the S&P 500 shows that spending on things such as equipment and buildings rose roughly 1.5% in the first three months of the year, according to S&P Global Market Intelligence. Half of the sectors measured showed a decrease in capital spending in the quarter. The U.S. economy added 533,000 jobs during the first three months of 2017, in line with the first quarters of 2016 and 2015.

Improvements in the quarter were led by financial, technology and basic-materials companies. The best sector was energy, where profits are up a staggering 647% from the year-ago period while revenue leapt 31%.

Profit gains were more muted for industrials, utilities and consumer staples. Many food and household products makers, including Colgate-Palmolive Co. and PepsiCo Inc., reported weak starts to the year.

Exxon Mobil Corp.'s first-quarter profit doubled but the company said its capex dropped 19% to $4.2 billion as it "remained disciplined in its investment." At Union Pacific Corp., finance chief Robert Knight highlighted that the railroad has cut annualized capital spending by $1.2 billion to $3.1 billion in the past couple of years.

There was one notable exception to the profit and sales gains: the U.S. telecom industry. Thomson Reuters estimates the group's revenue dropped 4.7% while earnings fell 4.5%.

The biggest telecom providers, Verizon Communications Inc. and AT&T Inc., cut prices and rolled out unlimited data plans in the quarter to combat customer defections to smaller rivals. With few new customers left to capture, the companies are struggling to grow when prices decline.

Some companies see more value in returning cash to shareholders than reinvesting it in the business. Semiconductor company Skyworks Solutions Inc. spent $55 million on capital expenditure in the quarter, while paying dividends of $52 million and repurchasing $95 million in shares. FlowServe Corp., a maker of pumps and valves, is planning to pay out $100 million in dividends in 2017 in addition to capital expenditure of $90 million.

Last week, U.S. Secretary of Commerce Wilbur Ross said the initial reading of first-quarter gross domestic product -- growth of just 0.7% -- included increased business investment mostly from mining exploration shafts and oil wells. He made the case for the Trump administration's business policies to help boost growth.

"Business and consumer sentiment is strong, but both must be released from the regulatory and tax shackles constraining economic growth," Mr. Ross said.

This week, the Institute for Supply Management said its closely watched index of U.S. manufacturing activity fell for the second month in row in April, though still shows expansion in the sector. In February, the manufacturing index reached its highest level since August 2014.

United Rentals Inc. CEO Michael Kneeland said the renter of construction equipment plans $1.5 billion in 2017 capital spending, up from $1.3 billion in 2016 and two years of declines, citing positive market trends. "We feel comfortable with that number, and it should match up well against the demand," he said on a conference call with investors.

"There really was nothing but tailwinds behind big companies in the first quarter," said Mark Zandi, chief economist of Moody's Analytics, noting that business conditions should remain good but profit margins may weaken as spending rises. The biggest hurdle facing companies is going to be the increasingly tight labor market.

"This is probably as good as it gets," he said. "I think businesses will have no choice but to invest aggressively in capex to improve productivity in the face of rising wages and compensation."

Write to Thomas Gryta at thomas.gryta@wsj.com and Theo Francis at theo.francis@wsj.com

(END) Dow Jones Newswires

May 06, 2017 02:47 ET (06:47 GMT)