If stories of massive corporate cash chests and fast-clip earnings growth at US companies have lulled you into believing the economic recovery is for real, here’s a wake-up call from the SocGen Global Quant Research team.
“US profits are not growing, companies are not underinvesting (they may in fact have overinvested), and corporates are carrying more (not less) net debt than they were in 2009. It would appear that many believe the opposite to be true, yet corporate report and accounts data seems to say otherwise,” says ‘Quant Quickie: Counterfactuals: Stagnant US profits, too much Capex and too much Debt,’ a research note from SocGen analysts Andrew Lapthorne, Rui Antunes, John Carson, Georgios Oikonomou, Charles Malafosse and Michael Suen.
Myth 1: Corporate cash earnings grew well in 2013
According to recent data from the U.S. Department of Commerce (“National Income and Product Account, GDP 3rd Quarter 2013,” U.S. Department of Commerce, December 5, 2013), third-quarter corporate profits on an after-tax basis were 11.1% as a share of GDP.
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During the twelve months ended in the second quarter the same figure read 10.9%. The WSJ observed this was the highest seen since 1929, and attributed this to “fat margins” due to a falling wage component as a percentage of sales, low interest rates, low effective tax rates and tight capital spending.
Further, the impression given by data providers such as I/B/E/S is that proforma profit, measured by EPS, has grown at an average 7% over 2013.
However, SocGen says that earnings reported by MSCI are more representative of the true picture – and these show that US corporate earnings have been almost flat the past year. The chart below shows the divergence between IBES proforma and MSCI.
Further, “Even these MSCI figures have been flattered by a reduction in the share count plus lower interest rates and tax charges. If we look at overall growth in earnings before interest and tax, or indeed gross cash flow, we find that neither has really moved for the last couple of years. It would appear then, that at an aggregate level, most profit growth is the result of astute financial engineering rather than improving cash flow,” is the clincher from SocGen.
In fact, the SocGen analysts observe that “US non-financial EBIT growth has been around zero for over a year and is below sales growth, implying margin contraction.”
Myth 2: US companies are sitting on mountains of cash
That’s true – but that’s not the complete picture – in fact, net debt (which excludes cash in its calculation) is higher by 15% compared to the level in 2008-09. So, all that cash is in fact already spoken for by lenders.
Myth 3: US companies are keeping a tight lid on capital spending
SocGen assess this in the light of capex spending as a percentage of sales, because growth in sales (and profits) is the catalyst for higher outlay on capex.
By this measure, US corporates are overspending – as apparent from the chart below for capex-to-sales ratios.
“Rather than being depressed, what we see is that capex levels versus sales are relatively elevated. If anything it would appear from this data that capex levels are too high – not too low – as many are saying,” observes SocGen’s research note.