Canaries in Q4 earnings coal mine looking sickly

December 9, 2011

By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Two canaries in the fourth-quarter earnings coal mine are looking sickly. DuPont and Texas Instruments now think their results will be weaker than they previously thought. U.S. multinationals’ earnings have been surprisingly robust up to now – but these bellwethers suggest that may be changing.

Chemicals and computer chips are two necessities for other industries around the world these days. When business slackens for the likes of DuPont and TI, it can be a sign of things to come for others. If manufactures think fewer autos, computers, or televisions will be sold in the coming months or quarters, they will cut orders for supplies today.

That said, rather than pointing to a drop in end-user demand, both companies pinned much of the blame for their shortfalls on conservative manufacturers wanting to hold onto as much cash as possible. Cutting inventories to the bone is one way to do this. It isn’t sustainable over the long run, but it raises the chances that a company can keep the lights on should financial markets seize up or demand plunge. While both companies said the slowdown occurred globally, it’s telling that the biggest hit was in Europe.

The two profit warnings could be false signals of an economic slowdown. If consumers keep buying cars, toys and televisions, supply chains will have to be restocked. The same could happen if continuing concerns about the stability and liquidity of the financial system abate.

Yet financial imbalances have been building for years, so are unlikely to be resolved overnight. And when corporate treasurers are worried about their cash positions, they are not making big investments or hiring. Even if the alerts from DuPont and TI are due to inventory reductions rather than falling demand, it’s a trend that could feed on itself and hit other company’s profits.

For the third quarter, earnings in the S&P 500 Index showed almost 18 percent year-on-year growth, Standard & Poor’s says. For the fourth quarter, though, more than twice as many companies have indicated earnings will be below expectations than above. Estimates of year-on-year earnings growth for the quarter, meanwhile, have been declining and now stand below 10 percent. If DuPont and TI are any indication, that downward trend has further to go.

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