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Despite Economic Rally, Companies Expect A Weaker 2012

02/22/2012 | 10:50am US/Eastern
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-- Companies cutting quarterly outlooks in greatest numbers since 1Q 2009

-- European economic fragility cited as drag on corporate forecasts

-- Cost-cutting may have hit its limit, as margins ease off 2011 peaks

By Alexandra Scaggs

Of

U.S. companies are dialing back their quarterly profit forecasts at the highest rate since early 2009, driven by unnerving European headlines along with rising commodity and energy costs.

Companies tend to understate their expectations for earnings, or guidance, because they're punished for missing estimates and rewarded for exceeding them, according to analysts and investors.

Historically, around 60% of Standard & Poor's 500 companies beat estimates each quarter. However, they have turned unusually pessimistic in forecasting a year that's already seen a more-than 8% increase in the S&P 500 Index. Macroeconomic uncertainty is weighing on companies' economic outlooks, and they may have hit a limit on cost-cutting, which became rampant during the financial crisis and U.S. recession.

Euro-zone finance ministers inked a tenuous EUR130 billion rescue deal for Greece, announced earlier this week. But several hurdles to a final agreement remain, and it remains uncertain whether Greece will meet the demands of creditors. European stocks were slightly lower Wednesday, partly on concern about the effectiveness of the plan.

Fifty-eight companies have released estimates for first-quarter earnings that fall below analyst consensus, compared with 23 that beat Wall Street. That's the largest ratio of negative to positive announcements since the first quarter of 2009, when the S&P 500 was on its way to bottoming out below 700 in early March.

"We're seeing more negative guidance than usual," said Greg Harrison, earnings analyst with Thomson Reuters. Estimated profits for 2012 have steadily fallen since October. The average S&P 500 company currently expects to add 8.3% in profits for the year. Just over a month ago, that estimate was at 10%.

Pepsi (>> PepsiCo, Inc.), for one, cut its outlook for fiscal year 2012 by more than 7% - from $4.40 a share to $4.08 a share - in part because the costs of the raw materials, including energy, used to make its products will rise. The company said raw material inflation will take $1.5 billion from its bottom line in an investor meeting after its Feb. 9 earnings announcement.

The Dow Jones-UBS Commodity Index has climbed 4.7% since the start of 2012. Since October 2011, crude oil has risen to about $105 per barrel from $75. Since early January, oil has gained $10 per barrel.

Worries about a recession in Europe have weighed heavily on companies' outlooks, says Dan Suzuki, US equity and quantitative strategist for BofA Merrill Lynch Global Research. Auto interior maker Johnson Controls (>> Johnson Controls, Inc.), for one, cut its estimate for fiscal year 2012 earnings by 5% because it expects weakness in the European market. PPG Industries (>> PPG Industries, Inc.), Estee Lauder (>> The Estee Lauder Companies Inc.) and Paccar Inc. (>> PACCAR Inc) also named an economic slowdown in the region as a drag on their 2012 guidance.

Many companies are also hitting a wall on just how much of their expenses they can cut after recessionary belt-tightening. "Margins have come off their peak," said Bill Stone, chief investment strategist for PNC's asset management group. Margins, the percentage of revenue that translates into profit, rose steadily from 2008 until recently, when the average rose to 9%. But this quarter, the average is expected to fall to 8.5%, meaning companies are having a tougher time eking out higher profits out of steady levels of revenue.

Predictions from corporations are no guarantee that profits will slow, of course, in part due to improving U.S. economic conditions. Investors like Stone aren't too worried about the downward shift in outlook. "Most corporate people would say they don't go to sleep at night without worrying about Europe. But generally, in the U.S. [economic] numbers are trending in the right direction."

-By Alexandra Scaggs, Dow Jones Newswires; 212-416-4125; alexandra.scaggs@dowjones.com;

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