Data on second quarter productivity is due out before the open and could present a mixed bag for Corporate America and the economy. Expectations are for a 1.4% annualized rate off of a decrease of 0.9% in the first quarter of the year. The year-over-year growth has been down sequentially in each quarter since the first quarter of last year and is typical of the latter stages of a recovery. A further slowdown in productivity could mean that employment will start to pick up in the coming quarters, but will also push unit labor costs upwards.
Unit labor costs only gained 0.9% in the first quarter over the previous two months, but were coming off of three consecutive quarters of increasing cost pressures, rising to a 2.1% annual gain in the fourth quarter of 2011. With about 80% of the companies in the S&P500 reporting, earnings are up just 0.6% during the quarter on revenue growth of 2.2%, well below the 6.0% sales growth seen in the first quarter.
While most have been quick to blame weakness on problems in Europe, I would say it also has a lot to do with costs and weakening margins. Since the recession ended, companies have been able to beat estimates by cutting costs in labor and holding off on capital expenditures. Margins are expected to be down 0.33% with 9 of the 16 sectors tracked by Zacks posting negative year-over-year margin comparisons. As revenues stagnate and companies find they can no longer squeeze costs, bottom-line earnings will miss and sentiment could take a tumble.
The pain of margin compression will be uneven through the consumer goods sector, as companies with agricultural components could see sharp increases due to an historic drought and heat across most of the United States. Grain prices have surged since June and costs could flow through to higher meat and dairy products as well.
Vice and Sugar versus Weak Growth and Margin Compression
Philip Morris International (PM) beat expectations with earnings of $1.36 per share on revenue of $8.1 billion in the second quarter. While results were basically flat from the same period last year, earnings over the last four quarters have increased 16% and revenues have increased 10% against the previous four quarters. The largest publicly traded manufacturer of tobacco products pays a 3.4% dividend yield and trades for 18 times trailing earnings. The addictive nature of the company's products help it pass on cost pressures, so margins remain firm. Further, the separation of operations from the U.S. business means it faces less regulatory and litigation risk.
The Coca-Cola Company (KO) beat expectations, though only marginally, to post earnings of $1.22 per share in the second quarter. Expectations for third quarter earnings are basically flat from the same period last year, but the company should continue to do well on emerging market growth and strong brand loyalty. Coca-Cola is an established sponsor of the Olympics and could see a bump in sales for the third quarter. The company recently announced interest in the beverage division of Singapore's Fraser and Neave. The acquisition would make Coca-Cola the market leader in soft-drinks sales in Malaysia and Singapore.
Procter & Gamble (PG) beat earnings expectations, but reported a decrease of 2.4% in earnings per share compared to the same period last year. The company has relatively less exposure to emerging markets, with only 40% of 2011 sales coming from the faster growing regions. The shares trade at 17 times trailing earnings, fairly expensive for a company with low organic sales growth typical of a mature industry. The company has recently announced a $10 billion cost cutting campaign through the next five years. While cutting costs may help support margins, the company needs to focus on product development and revenue growth.
Archer Daniels Midland (ADM) missed earnings badly for the fourth quarter, posting $0.43 per share. Not only did net income fall by 25.5% from the same period last year, but the company's operating margin fell 2.4% as well. Higher corn and soybean prices brought weaker margins in every business segment and limited pricing power means that margins could compress further in coming quarters. The company invested heavily in corn ethanol production over the last 10 years and is now suffering from overcapacity and weak profitability.