Corporate Profits Have Peaked And Will Tank Next Year

As the old saying goes, that which can’t continue won’t. Wal-Mart, that quintessential wage-squeezer, is finding this out:

h2 Wal-Mart Lowers Forecast as Pay Raises, Currency Take Toll /h2

(Bloomberg) – Wal-Mart Stores Inc. (NYSE:WMT), the world’s biggest retailer, cut its annual earnings forecast for the year, hurt by currency fluctuations and a high-profile pay bump for U.S. employees.

The company now expects profit of $4.40 to $4.70 a share this fiscal year, which runs through January, according to a statement on Tuesday. Wal-Mart had previously forecast earnings of as much as $5.05 a share. Wal-Mart also posted second-quarter earnings that missed analysts’ estimates. Profit amounted to $1.08 a share in the period, excluding some items, the Bentonville, Arkansas-based company said. Analysts had expected profit of $1.12 a share, according to data compiled by Bloomberg.

Wal-Mart shares fell as much as 3.3 percent to $69.55 in New York, the biggest decline since May 19. The stock had already slid 16 percent this year through Monday’s close.

Wal-Mart announced plans in February to raise wages to at least $9 an hour this year and $10 by 2016, along with a related effort to improve training and bolster hours. The move will reduce profit by 24 cents a share, Wal-Mart said on Tuesday. That includes an 8-cent hit in the fiscal third quarter, which runs through October. Wal-Mart had previously said the effort would cost 20 cents this year.

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The Dollar Is Just Too Damn Strong
It’s up by 20% – 30% against most other currencies since 2013, raising the effective price of US exports and lowering the value of income from overseas corporate divisions (which come in the form of depreciating currencies like the euro and yen). The impact:

h2 Here’s How Much the Strong Dollar Hurts American Companies /h2 (Bloomberg) – American companies had a rough start to 2015 as they watched profits from overseas subsidiaries slide.

Exactly how much blame should we assign to the currency markets? Two economists at the Federal Reserve have an idea.

U.S. corporate profits fell about 1.4 percent in the fourth quarter last year before plummeting 5.2 percent in the first quarter this year, partly driven by a plunge in the amount American companies’ foreign affiliates earned. Of the decline in overseas subsidiary profits caused by the appreciating currency and cheaper oil imports, about a third probably came specifically from the greenback, Carol Bertaut and Nitish Sinha wrote in a post this month.

Fed policy makers have voiced concern about the strong dollar’s drag on exports, both in Federal Open Market Committee minutes and in speeches (the FOMC will release a new policy statement at 2 p.m. on Wednesday). It’s a major point of concern for monetary policy-watchers as Fed officials debate when to go ahead with the first interest rate increase since 2006.

China Has Stopped Buying Our Stuff
China tripled its debt post-2009 and spent most of the proceeds on infrastructure like roads and airports. US corporations got a big piece of this business, either by selling raw materials and technology to Chinese builders, or doing the work themselves. Now that bubble has burst, leaving lower commodity prices and excess capacity in its wake:

h2 China’s Woes Echo in U.S. Earnings /h2 (Wall Street Journal) – With the U.S. recession behind them and the European fiscal crisis fading, American companies are grappling with a new threat: China’s economic blues.

In quarterly conference calls, U.S. executives recited a litany of pain, from mild to severe, resulting from a slowdown in China’s economy, the world’s second-largest.

Engine-maker Cummins Inc (NYSE:CMI)., for example, said demand for excavators in China fell 34% in the second quarter from a year ago with no signs of improvement. For such companies as Weyerhaeuser Company (NYSE:WY), less construction in China means logs and lumber pile up in the U.S., pushing down prices.

“China was weak in the quarter, and we expect it to be weak as we move forward,” Robyn Denholm, chief financial officer of Juniper Networks Inc (NYSE:JNPR)., told investors. China pulled down the networking-gear maker’s Asia-Pacific revenues by 3% from the prior quarter; without China, they would have risen 11%.

It comes at a tough time for U.S. businesses. Overall, companies in the S&P 500 index are on track to eke out a 1.2% increase in second-quarter earnings, according to data from Thomson Reuters. That is the slowest growth since fall 2012.

The modest earnings growth was recorded on a 3.5% decline in revenues—the biggest drop in nearly six years—suggesting that much of the profit gain is from cost-cutting, buybacks or other maneuvers, rather than increased sales.

The slowdown in China was evident last quarter in everything from business flights to elevator sales to car purchases. Rockwell Collins Inc (NYSE:COL). said the flight-services industry has seen international business-jet flights fall 10% this year, largely in and out of China, Russia and the Middle East. DuPont (NYSE:DD) Co., which makes temperature-resistant materials for components in the automotive industry, lowered its growth forecast for the Chinese auto industry in the second half of the year to between 2% and 3%, from past rates of 5% or higher.

Add it all up, and US corporations are looking at another year of falling revenues and much lower earnings at a time when a lot of stocks are priced for, if not perfection, at least high-single-digit growth.

And none of these headwinds are going away. US workers have just begun to redress the past decade’s injustices, and now that higher minimum wage laws have been proven to be political winners, a whole generation of would-be mayors and governors will be pushing them.

China has done exactly nothing to bring its finances back into balance so will either see a 2016 crash or bail out its banks and builders and drift into a Japanese-style lost decade. Either way, its days of sucking up all the world’s extra oil, coal and earth movers are over.

And with the rest of the world in various stages of decline, crisis or chaos while the Fed seems to sincerely want higher domestic interest rates, the dollar isn’t poised to retrace the past year’s spike. Just the opposite.

So it’s a safe bet that US corporations will, in the aggregate, be less profitable next year than this year and — to the extent that earnings dictate market cap — a lot less valuable.

Written By: John Rubino