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FedEx forecast bodes ill for U.S. profit outlook
2008-06-18
NEW YORK (Reuters) - Federal Express may be the proverbial canary in the coal mine. The dismal outlook from the package delivery company on Wednesday may herald an explosion of profit warnings from companies struggling with soaring commodity input costs and a sluggish economy. The upshot is that an already-weakening profit outlook for Corporate America could get much worse, dragging share prices down further. FedEx's warning on its profit outlook sent Wall Street stock indexes tumbling, with the blue-chip Dow Jones industrial average (.DJI) dropping 1.1 percent to close at its lowest level in three months. "It would now seem that the hope that things will be better in the economy by the third quarter is pie-in-the-sky," said Eric Kuby, chief investment officer at North Star Investment Management Corp in Chicago. Analysts now see earnings of companies in the benchmark Standard & Poor's 500 (.SPX) index falling by 9.0 percent in the second quarter from a year earlier, according to Thomson Reuters research. That is significantly weaker than just two weeks ago, when the consensus estimate called for a drop of 7.3 percent, about four times worse than the average expectation at the beginning of April. While analysts still hold out hope that profits will recover in the third quarter, even those estimates are eroding. According to Thomson Reuters data, analysts expect profits to grow by 13.9 percent in the third quarter, down from expectations of 17.3 percent in April. FedEx (FDX.N) now forecasts weak earnings into next year, specifically blaming rising fuel costs, after it reported a loss of $241 million for the three months ended May 31. The express delivery company is regarded as an indicator of U.S. business activity because of the high volume of consumer and commercial shipments it handles. FedEx's forecast dashed hopes that companies would be able to keep on passing higher input costs to customers. "It's clear you can only pass on costs to a certain point until people stop buying," said North Star's Kuby. It appears the market may get little to no opportunity to catch its breath after digesting the FedEx warning. Shortly after the closing bell, railroad operator Burlington Northern Santa Fe (BNI.N) forecast weaker-than-expected earnings for the second quarter, citing both higher fuel costs and disruption to its track network caused by the floods in the U.S. Midwest. Since the end of the first quarter, crude oil futures for immediate delivery on the New York Mercantile Exchange have risen from $101 per barrel to $136 , while corn futures on the Chicago Board of Trade hit an all-time high this week amid concerns over crop prospects. Two surveys released on Wednesday showed that faced with surging energy prices, a credit crunch, and the worst housing market slump in decades, the leaders of corporate America have a bleaker view of the U.S. economy. The surveys, conducted by the Business Roundtable and Duke University/CFO Magazine showed U.S. chief financial officers and chief executive officers expect to cut jobs to cope with rising costs. The surging commodity costs have already prompted a number of companies in a variety of sectors to raise prices. Dow Chemical Co (DOW.N), the biggest U.S. chemical manufacturer, said last month it would raise prices by 20 percent, while United Technologies Corp (UTX.N) upped prices at its air conditioner unit. Some companies have been more successful than others at passing on costs. Cereal-maker General Mills Inc (GIS.N) said it expects earnings for the recently ended fiscal year to beat expectations as the company has been able to offset rising commodity costs with price increases. But even among those companies whose customers have seemed to take the price rises in their stride, it remains to be seen whether they can adapt to higher costs over a sustained period of time, said Subodh Kumar, chief investment strategist at Subodh Kumar & Associates in Toronto. "I think analysts will have to cut their estimates, and my feeling is that the FedEx news may be the strong dose of realism needed as a catalyst for analysts to cut. There's been a gradual decline in forecasts so far and a rash of estimate cuts is long overdue," said Kumar. "Raw materials costs have been going up for a whole range of goods and services, but the weaker the economy gets the harder it will be to pass rising prices to consumers. We're already seeing that in the airlines industry," Kumar said. Airlines have been cutting jobs and capacity, raising fares, and charging new fees to stay afloat as they struggle with record fuel costs. Goldman Sachs chief investment strategist David Kostin wrote in a note to clients this week that he expects surging input costs to keep on pressuring corporate profit margins. Goldman Sachs Commodities Research unit estimates many energy, metals and agriculture commodity prices will jump by an average of 50 percent versus last year. During times of commodity price inflation operating margins have tended to fall and price to earnings multiples have tended to contract, Kostin wrote. Historically, consumer discretionary and telecom services companies' operating margins have contracted the most during accelerating inflationary periods, Kostin wrote, while information technology and materials companies have tended to weather the storm. Margins at energy companies usually shrink as well, he wrote, possibly due to a lag in pricing.
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