Local Earnings May Have Peaked

By ANDY FIXMER

Staff Reporter

Fueled by cash from refinances, low interest rates and an uptick in the economy, L.A.’s public companies hummed along pretty well during the first half of 2004 many posting strong, sometimes record profits.

But as the second half gets under way, much of the easy money has been made. The Federal Reserve has begun raising interest rates, endangering the refinance boom that has subsidized the recovery. Tax refunds have been spent, the cost of fuel and other commodities are rising, and for public companies, the comparisons with year-ago profits the classic benchmark for gauging earnings performance will get tougher from here on out.

“Many people may have already tapped all their equity,” said Joan Storms, a research analyst covering retailers for Wedbush Morgan Securities Inc. “The banks may still be willing to lend but consumers are too busy paying off all their debt to borrow more. At this point consumers are saying, ‘We’re going to take a break from spending.'”

For the second quarter, companies in the S & P; 500 are reporting earnings increases averaging 21 percent, said Gint Rimas, senior analyst for Thomson Financial, which tracks earnings estimates and performance.

It was the fourth straight quarter of year-over-year earnings increases of 20 percent or higher, Rimas said. What’s more, earnings estimates rose as the quarter wore on, instead of declining as they usually do.

Both are rare occurrences that should signal higher stock prices and a roaring economy. But a closer look at the numbers illustrates why investors continue to be so apprehensive.

The sector showing the most upward revision, Rimas said, is energy, where oil prices have stubbornly remained above $40 a barrel. “The major downside is the tax on the consumer and the negative impact on other industries,” Rimas said particularly transportation and industrial companies that consume a lot of energy.

There hasn’t yet been any evidence of higher oil prices biting into earnings in other industries. But it’s likely they will make their impact felt, as will the expected rise in rates. Already there are jitters in the software and retail sectors, although Rimas sees earnings growth holding up pretty well overall for the second half, with about 15 percent growth in profits for each of the third and fourth quarters.

Conflicting signs

Changes in earnings estimates since April 1 at several large local companies illustrate the economic strains. At Amgen Inc., the Thousand Oaks-based biotech company, earnings estimates are essentially unchanged for the second half of the year, according to Thomson Financial. (Amgen reports quarterly earnings on Thursday.) Same story with Burbank-based media giant Walt Disney Co., as advertising spending continues to resist breaking out of its slump.

But since April 1, oil and gas producer Occidental Petroleum Corp. has seen its second-half earnings estimates surge to $2.46 a share from $1.89, a 30 percent increase. That’s in addition to the 41-cent increase in the average estimate for Occidental’s second quarter earnings, to $1.43 a share. (Occidental is expected to report its second quarter earnings on Monday.)

Earnings estimates for lender Countrywide Financial Corp. have also risen. But where the increase in Occidental’s estimates was spread throughout second, third and fourth quarters signaling confidence that oil prices will remain high Countrywide’s were concentrated mainly in the already-completed second quarter a less-than-confident vote that interest rate increases will be moderate.

“Everyone is holding their breath and seeing how much they can sustain in this real estate boom,” said J. Han Park, senior vice president at Nara Bancorp Inc., another local lender. “We are all very focused on the bubble going on in real estate.”

Still, Park will remain optimistic if the Federal Reserve keeps interest rates low enough for home sales to remain brisk.

“Everything hinges on interest rates,” he said. “Everybody expects the prime rate will go up to about 6 percent, but if they raise it like crazy and it goes up to 9 percent, we will start to have default issues. People are leveraged too much and we’ll start to see foreclosures.”

Each bank sets its own prime lending rate, but the rates are tied to the banks’ borrowing costs, which are set by the Federal Reserve. As of last week, the prime rate, as tracked by the Wall Street Journal, was 4.25 percent, up from 4 percent one month earlier.

Steady footing

Despite some concern about rising interest rates, Park said Nara Bancorp is poised to have another two quarters of solid earnings based on the performance of its new branches and loan offices and the partnerships it has entered into for offering mortgages and other financial services.

A steady rise in rates wouldn’t deter firms from borrowing to expand their business, Park said.

“Wall Street has been bracing for it, small businesses have been bracing for it, so when it happens it’s not going to be a shock,” he said. “When they do expansion calculations, they don’t look at what the payments will be now but, worst case, what they would be if rates go up 2 percent over the next few years.”

Nevertheless, a drop-off of 8 percent in demand for commercial loans spurred City National Corp. last week to cut its overall loan growth estimate for this year to between 4 percent and 6 percent from between 6 percent and 9 percent.

Chairman and Chief Executive Russell Goldsmith said the loan growth is representative of the overall economy.

“This is what I would call an environment of moderate growth,” he said. “Business confidence and loan growth lag the economy generally. The good news is the economy is growing, loan demand is rising but they are both doing so in a measured moderate way.”

Shopping mall operator Macerich Co. has been trying to limit the effect of rising rates on profits by locking in variable-rate debt now, according to Tim O’Hern, chief financial officer. “We’re trying to fix rates,” he said. “If we have a variable rate loan, we’re trying to cap it or fix at some rate now.”

O’Hern said Macerich continues to receive strong demand from retailers for mall space.

“The foot traffic has been good, the demand for new space has been strong and occupancy levels are high,” he said. “We see that holding steady.”

The company recently reaffirmed its fiscal year 2004 earnings outlook of $1.79 to $1.89 per share.

Retail mixed

Meanwhile, results from retailers have been mixed.

Videogame manufacturer Activision Inc. has seen earnings swell from the popularity of its “Spiderman 2” and “Shrek 2” games. On May 7, the company increased its revenues and earnings estimates for the fiscal year ending in March 2005.

However, Mattel Inc. relying on toys based on those same movies expects to report soft earnings for the year. Sales of the company’s mainstay Barbie have been weak, according to Gary L. Cooper, a research analyst with Banc of America Securities, who dropped Mattel’s stock to “sell” in a July 7 report. “As we have witnessed, as Barbie goes so goes Mattel’s stock,” he wrote. “And in our opinion Barbie’s business is not going anywhere.”

Mattel is being squeezed by oil price hikes, which make distribution costs more expensive and increase the cost of the resins used by the toy manufacturer.

“High fuel prices continue to negatively impact Mattel’s transportation and raw materials costs,” Cooper wrote. “Of the major toy companies, we believe Mattel is the most impacted by rising resin prices due to a greater percentage of raw material costs from resin.”

The company, which is preparing to release its quarterly earnings, declined comment, said spokeswoman Lisa Marie Bongiovanni.

These are some of the same problems that are hitting Mattel’s customers higher gas prices at the pump, food costs, and increases in insurance and education costs.

“It’s inflation everywhere you turn things are up year-over-year,” Storms said. “It’s not turning up in the government’s statistics but as a consumer you are seeing it everywhere. It’s definitely cutting into discretionary spending.”