Copyright ©2004 Global Insight, Inc. Outlook for Corporate Profits Which are the Leading Sectors? Mark Killion, CFA Managing Director May 26, 2004

Copyright ©2004 Global Insight, Inc.

Outlook for Corporate ProfitsOutlook for Corporate ProfitsWhich are the Leading Sectors?Which are the Leading Sectors?

Mark Killion, CFAManaging Director

May 26, 2004

Copyright ©2004 Global Insight, Inc. 2

Outlook for Corporate Profits – Agenda:Outlook for Corporate Profits – Agenda:

Corporate Profits are key to: understanding asset valuation, credit quality anticipating the CapEx cycle and employment growth

NIPA Corporate Profits to illustrate recent trends The “cleanest” measure of current operating earnings Sector level profits are more reliable than the “Top down” headline

total profits number

ROE Framework to analyze future prospects for profits Impact of operating leverage and financial leverage Market discipline forces a more efficient use of CapEx & Debt

“Normalized” Earnings Growth for Sectors What is the outlook after the “bounce” of 2003-2004? Which sectors enjoy the fastest growth?


0

5

10

15

20

25

30

35

40

45

50

55

60

65

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

E

20

05

E 0

100

200

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

S&P 500 Profits from SEC via S&P (EPS, LHS)

NIPA Profits from IRS via BEA (Bill.$, RHS)

Profits as S&P 500 GAAP (EPS, LHS)

Profits as NIPA (Bill.$, RHS)

S&P 500 US$ Earnings Per Share US Corporate Profits US$ Billion

Two Measures of US Corporate ProfitsTwo Measures of US Corporate Profits

Source: Standard & Poor’s, US BEA, GII ForecastsSource: Standard & Poor’s, US BEA, GII Forecasts

Two common measures of corporate profitability

Filings with SEC by 500 large companies shown as “GAAP” per-share net income

Filings with the IRS by all companies shown as “NIPA” current profits in billion US$

NIPA is the “cleanest” measure of operating profits:

counts stock options as operating expenses

no ability to “fudge” from balance sheet

no “survivorship bias” has both “top down” &

“bottom up” consistency

Both measures are up in 2004, slower growth expected in 2005-2008


How Does the Current Profit Recession Compare to the Previous Profits Recession of 1988-1992?

How are US Profits Faring in the Business Cycle?How are US Profits Faring in the Business Cycle?

60

70

80

90

100

110

120

130

140

150

160

-7 -5 -3 -1 1 3 5 7 9 11 13 15 17 19 21 23

Ind

ex

10

0 =

Cy

cle

P

ea

k

Index for 1988 Q4 to 1994 Q1--With CCA Adjustment

Index for 1997 Q4 to 2003 Q4--With CCA Adjustment

Index for 1997 Q4 to 2003 Q4--No CCA Adjustment

U.S. Corporate Profits in Quarters After Cycle Peaks (88-92 Vs. 97-03) (Index = 100 at Cycles Peak of Corporate Profits: 1988 Q4 and 1997 Q4)

0

50

100

150

200

250

300

350

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-I

2003

-II

2003

-III

2003

-IV

Ad

just

men

t in

Bill

. US

$0

5

10

15

20

25

30

35

Ad

just

men

t as

% o

f P

rofi

ts

CCA Adjustment in US$ (LHS)

CCA Adjustment as % of Base (RHS)

The “Top – Down” Adjustment for Capital Consumption Has Become Unreliable!

(CCA Adjustment from Tax-Based to Economic Depreciation Rates Where A Positive Number indicates a Boost to NIA Corporate Profits -- by Taking Back

Some Tax Based Depreciation Claimed against Profits)

Source: US BEASource: US BEA

Bottom Scale Shows the Number of Months Prior and After the Previous Peak.


Compare the Latest Profits Trends in the U.S. to the U.K.Compare the Latest Profits Trends in the U.S. to the U.K.

-4

-1

2

5

8

11

14

17

20

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

E

2005

E

18

19

20

21

22

23

24

25

26

UK NIA Corporate Profits Growth (LHS)

UK Corporate Profits Share of GDP (RHS)

United StatesCorporate Profits Growth Rate (LHS), and

Profits as Shares of GDP (RHS)(Percent)

-8

-4

0

4

8

12

16

20

24

1984

1985

1986

1987

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004 E

2005 E

2

4

6

8

10

12

14

US NIA Corporate Profits Growth (LHS)

US Corporate Profits Share of GDP (RHS)

United KingdomCorporate Profits Growth Rate (LHS), and


Source: GII World Economic ServiceSource: GII World Economic Service


-4

-1

2

5

8

11

14

17

20

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004 E

2005 E

14

15

16

17

18

19

20

21

22

France NIA Corporate Profits Growth (LHS)

France Corporate Profits Share of GDP (RHS)

What are the Latest Trends in European Profits?What are the Latest Trends in European Profits?Compare Germany to FranceCompare Germany to France

FranceCorporate Profits Growth Rate (LHS), and


-4

-1

2

5

8

11

14

17

20

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004 E

2005 E

14

15

16

17

18

19

20

21

22

Germany NIA Corporate Profits Growth (LHS)

Germany Corporate Profits Share of GDP (RHS)

GermanyCorporate Profits Growth Rate (LHS), and


Source: GII World Economic ServiceSource: GII World Economic Service


How Have Key U.S. Sectors Fared Recently?How Have Key U.S. Sectors Fared Recently?Summary from Recent DataSummary from Recent Data

--Sectors that have done well:

Financial sub sectors such as Mortgages, Securities, Leasing

Retail, Wholesale trade Consumer Non Durables

--Sectors that were hit hard but are now recovering:

Fabricated Metals Transportation, Warehousing Semiconductors & Equipment I.T. Consulting & Services

--Sectors Hard Hit with No Recovery Yet:

Industrial Machinery and Equipment

Motor Vehicles and Parts Telecommunication Services Electronics, Hardware I.T.

--Oil and Energy have Surged

--Chemicals & related products are stable but below 1990s peaks

Source: GII World Industry ServiceSource: GII World Industry Service


Which US Sectors are Generating Profits?Which US Sectors are Generating Profits?


AnnualAnnual AnnualAnnualLast 8 QuartersLast 8 Quarters Last 8 QuartersLast 8 Quarters

0

50

100

150

200

250

300

1996 1997 1998 1999 2000 2001 2002 2002 -I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Rest of the World Net

Receipts from the Rest of the World

Payments to the Rest of the World

Sectors with Past Weaknesses Turning into RecoverySectors with Past Weaknesses Turning into Recovery(Billions of US$)(Billions of US$)

0

50

100

150

200

250

300

1996 1997 1998 1999 2000 2001 2002 2002-I

2002-II

2002-III

2002-IV

2003-I

2003-II

2003-III

2003-IV

Banking (In Federal Reserve System)

Retail Trade

Financial--NonBanking

Sectors with Steady Profits – Future Pressure? Sectors with Steady Profits – Future Pressure? (Billions of US$)(Billions of US$)


Which US Sectors are Recovering or Stalling?Which US Sectors are Recovering or Stalling?



-5

0

5

10

15

20

25

30

35

40

1996 1997 1998 1999 2000 2001 2002 2002 -I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Fabricated Metal Products

Other durable goodsTransportation and Warehousing

Sectors with Past Weaknesses Turning into Sectors with Past Weaknesses Turning into RecoveryRecovery

(Billions of US$)(Billions of US$)

0

10

20

30

40

50

60

70

80

90

100

1996 1997 1998 1999 2000 2001 2002 2002-I

2002-II

2002-III

2002-IV

2003-I

2003-II

2003-III

2003-IV

Utilities

Food & Related Products

Wholesale Trade

Sectors with Steady or Improving ProfitsSectors with Steady or Improving Profits(Billions of US$)(Billions of US$)


0

5

10

15

20

25

30

35

1996 1997 1998 1999 2000 2001 2002 2002 -I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Petroleum & Coal Products

Chemicals & Products

-8

-3

2

7

12

17

1996 1997 1998 1999 2000 2001 2002 2002 -I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Motor Vehicles, Bodies and Trailers, and Parts

Industrial Machinery & Equipment

Sectors with Exposure to Oil Related FactorsSectors with Exposure to Oil Related Factors(Billions of US$)(Billions of US$)

Sectors With No Recovery Yet in ProfitsSectors With No Recovery Yet in Profits(Billions of US$)(Billions of US$)





-20

-15

-10

-5

0

5

10

15

1996 1997 1998 1999 2000 2001 2002 2002-I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

EPS: Telecommunication Sector

EPS: Information Technology Sector

-60

-50

-40

-30

-20

-10

0

10

20

30

1996 1997 1998 1999 2000 2001 2002 2002- I 2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Info. & Communication Technology

Computer and Electronic products

Electrical Equipment, Appliances, andComponents

Why is Company EPS Rising For Technology?Why is Company EPS Rising For Technology?(Sector Earnings Per Share (EPS))(Sector Earnings Per Share (EPS))

Technology Sectors Still Under Pressure Technology Sectors Still Under Pressure (Billions of US$)(Billions of US$)

Source: Standard & Poor’s, US BEASource: Standard & Poor’s, US BEA




-30

-20

-10

0

10

20

30

40

1999 2000 2001 2002 2002 -I

2002 -II

2002 -III

2002 -IV

2003 -I

2003 -II

2003 -III

2003 -IV

Semiconductors

Semiconductor Equipment

Computer Hardware and Storage

Strength in Tech. IT & EntertainmentStrength in Tech. IT & Entertainment (Earnings Per Share (EPS))(Earnings Per Share (EPS))

Semiconductors Leading Technology Semiconductors Leading Technology Hardware RecoveryHardware Recovery(Earnings Per Share (EPS))(Earnings Per Share (EPS))

Source: Standard & Poor’s, US BEASource: Standard & Poor’s, US BEA



-5

0

5

10

15

20

25

1999 2000 2001 2002 2002 -I

2002-II

2002-III

2002-IV

2003 -I

2003-II

2003-III

2003-IV

Internet software and Services

System and Aplication Software

IT Consulting and Services

Home Entertainment Software


Which US Sectors are Generating Profit Growth?Which US Sectors are Generating Profit Growth?

-1.5 0.5 2.5 4.5 6.5 8.5 10.5 12.5

Energy

Information Technology

Financials

Telecommunication Services

Materials

Utilites

Industrials

Health Care

Consumers Staples

Latest 4 Quarter EPS Dollar Increase over Previous 4 Quarters: (Q12003 through Q4 2003 EPS minus Q1 2002 through Q4 2002 EPS )

1 Year Historical $EPS Growth for US Sectors1 Year Historical $EPS Growth for US SectorsRanked by Slowest to Fastest EPS $ GainRanked by Slowest to Fastest EPS $ Gain(Latest 4 Quarter EPS Dollar Increase over Previous 4 Quarters: (Latest 4 Quarter EPS Dollar Increase over Previous 4 Quarters:

Q1 2003 through Q4 2003 EPS minus Q1 2002 through Q4 2002 EPS )Q1 2003 through Q4 2003 EPS minus Q1 2002 through Q4 2002 EPS )

Source: Standard & Poor’sSource: Standard & Poor’s

7.16

0 1 2 3 4 5

Energy

Technology

Financials

Telecoms

Materials

Utilites

Industrials

Health Care

Consumers Staples

2003 Q4 EPS

Q4 2003 Diluted EPS for U.S. Sectors Q4 2003 Diluted EPS for U.S. Sectors


Which are the Largest Sectors?Which are the Largest Sectors?

Materials3%

Industrials11%

Consumer Staples

12%Health Care13%

Financials20%

Consumer Discretionary

11%

Utilities3%

Energy7%

Inform'n Technology

16%

Telecomm Services

4%

Banking and Finance is the largest S&P 500 sector in terms of sales, profits and market capitalization

Financials share of Market Cap. would roughly double if leasing & other finance is taken from Autos, Industrial, Retail, etc.

In Europe the Financial Sectors’ share of Total Market Capitalization is even higher (29%)

The US Financial sector accounts for 33% of Total US NIPA profits

Sector Shares of S&P 500 Total Market Capitalization, in Percent

Source: Standard and Poors, GII CalculationsSource: Standard and Poors, GII Calculations


Sales of Top 10 Companies as % of Total World Sector SalesSales of Top 10 Companies as % of Total World Sector Sales(Source: Top Ten Company Sales from WorldScope; Total Global Sales from GII’s WIS)(Source: Top Ten Company Sales from WorldScope; Total Global Sales from GII’s WIS)

0 10 20 30 40 50

Industrials

Basic Materials

Consumer Staples

Health Care

Consumer Discr.

Financials

Technology

Utilities

Telecomm Svs.

Energy

Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & GII CalculationsGII Calculations

Sector Operating Characteristics:Sector Operating Characteristics:Concentration RatioConcentration Ratio

How Concentrated are Sectors?How Concentrated are Sectors? Global Sales Concentration Ratios for GICS 10 Economic SectorsGlobal Sales Concentration Ratios for GICS 10 Economic Sectors

(Percent of Total Worldwide Sector Sales Accounted for the 10 largest Companies)(Percent of Total Worldwide Sector Sales Accounted for the 10 largest Companies)


Return On Equity (ROE) as Measure of ProfitabilityReturn On Equity (ROE) as Measure of Profitability

ROE Framework IdentityROE Framework Identity::

Return on Equity (NI/Equity) =Return on Equity (NI/Equity) =

Profit Margin (NI/Sales) *Profit Margin (NI/Sales) *

Asset Turnover (Sales/Assets) *Asset Turnover (Sales/Assets) *

Financial Leverage (Asset/Equity)Financial Leverage (Asset/Equity)

Where: NI = Net Income; Equity = Book Value of Where: NI = Net Income; Equity = Book Value of Equity, Valued at the End of the Preceding Period; Equity, Valued at the End of the Preceding Period; Assets are Total Current Period; Sales are Gross;Assets are Total Current Period; Sales are Gross;

( * Denotes a multiplication sign)( * Denotes a multiplication sign)

DuPont Ratio InterpretationDuPont Ratio Interpretation::

ROE is always described by some combination of:ROE is always described by some combination of:

profit margins,profit margins, reflecting efficiency in production, the mixture reflecting efficiency in production, the mixture of fixed versus variable cost and/or the presence of pricing powerof fixed versus variable cost and/or the presence of pricing power

asset turnover,asset turnover, showing the degree to which company assets showing the degree to which company assets are generating salesare generating sales

financial leverage,financial leverage, showing the extent to which the asset showing the extent to which the asset base is financed by debtbase is financed by debt

In this framework, the component “DuPont” ratios In this framework, the component “DuPont” ratios outline the relationship that profits have with sales, outline the relationship that profits have with sales, pricing power, balance sheets and industry structure. pricing power, balance sheets and industry structure.

““DuPont System” ROE FrameworkDuPont System” ROE Framework shows the shows the rate of return that rate of return that management earns on capital provided by the shareholdersmanagement earns on capital provided by the shareholders

(Profits calculated (Profits calculated relative to the equity interest, after accounting for payments to all other capital suppliers)relative to the equity interest, after accounting for payments to all other capital suppliers)

Source: Source: Investment Analysis and Portfolio ManagementInvestment Analysis and Portfolio Management, , ByBy Frank K. ReillyFrank K. Reilly & & Keith C . BrownKeith C . Brown South-Western, Nov, 2002.South-Western, Nov, 2002.


Return On Equity Return On Equity shows shows rate of return that management rate of return that management earns on capital provided by the shareholdersearns on capital provided by the shareholders

0

2

4

6

8

10

12

14

16

18

20

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2

3

4

5

6

7

8

ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS

What has been the Return on Equity What has been the Return on Equity Performance in the US?Performance in the US?

US Posted Excellent ROE record through 1997:US Posted Excellent ROE record through 1997:Problem of Falling Asset Efficiency, related to M&A Problem of Falling Asset Efficiency, related to M&A purchases and CapEx spendingpurchases and CapEx spendingLargely offset by Production Efficiency, Rising MarginsLargely offset by Production Efficiency, Rising MarginsIncrease in Operating LeverageIncrease in Operating Leverage

Pressure on margins accumulated from Mid 1990s:Pressure on margins accumulated from Mid 1990s:Compression from Asian / Russian crises in 1998Compression from Asian / Russian crises in 1998Increase in Financial leverage to compensateIncrease in Financial leverage to compensate

What Happened in 2001-2002?What Happened in 2001-2002?High operating leverage killed margins when growth slowedHigh operating leverage killed margins when growth slowedDeteriorating credit quality, corporate malfeasanceDeteriorating credit quality, corporate malfeasanceBalance sheet impacts of restructuringBalance sheet impacts of restructuring

Recovery in 2003:Recovery in 2003:Margin recovery from cost cutting, rising salesMargin recovery from cost cutting, rising salesIncrease in leverage to harvest low interest ratesIncrease in leverage to harvest low interest rates

Component RatiosROE in %

USUS Corporate Return on Equity Corporate Return on Equity Total for 1000 US Corporations in the GICS Total for 1000 US Corporations in the GICS

Sector Classification SchemeSector Classification Scheme

Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations


Return On Equity – Return On Equity – For Continental Europe and the U.K.For Continental Europe and the U.K.

0

2

4

6

8

10

12

14

16

18

20

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2

3

4

5

6

7

8

9

10

11

12



Continental EuropeContinental Europe Corporate Return on EquityCorporate Return on Equity

Total for 500 Corporations in the GICS Sector Total for 500 Corporations in the GICS Sector Classification SchemeClassification Scheme


0

2

4

6

8

10

12

14

16

18

20

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2

3

4

5

6

7

8

9

10

11

12


United KingdomUnited Kingdom Corporate Return on EquityCorporate Return on Equity

Total for 250 Corporations in the GICS Sector Total for 250 Corporations in the GICS Sector Classification SchemeClassification Scheme


0 5 10 15 20 25

Telecommunication Svs.


Materials

Utilities


Total

Energy

Industrials

Financials

Health Care

Consumer Staples

Europe United States

What is the Sector ROE Performance?What is the Sector ROE Performance?

Long Run Historical ROE for US and European SectorsLong Run Historical ROE for US and European SectorsRanked by European Perspective – Largest to SmallestRanked by European Perspective – Largest to Smallest

(Average ROE for US & European Sectors (X UK), Average over 1998-2003, Top 10 GICS Economic Sectors)(Average ROE for US & European Sectors (X UK), Average over 1998-2003, Top 10 GICS Economic Sectors)

Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & World Industry Service (WIS) CalculationsWorld Industry Service (WIS) Calculations


Sector Level Return On Equity Sector Level Return On Equity -- Health Care-- Health CareComparison of Europe and United StatesComparison of Europe and United States

ROE in % Component Ratios

European Health Care ROEEuropean Health Care ROETotal for all Euro. X UK Corporations in Total for all Euro. X UK Corporations in

the Health Care GICS Sectorthe Health Care GICS Sector

US Health Care ROEUS Health Care ROETotal for all US Corporations in the Total for all US Corporations in the

Health Care GICS SectorHealth Care GICS Sector

0

5

10

15

20

25

30

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

0

3

6

9

12

15




0

5

10

15

20

25

30

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

0

3

6

9

12

15




US Telecommunication Services ROEUS Telecommunication Services ROETotal for all US Corporations in the Total for all US Corporations in the Telecommunications GICS SectorTelecommunications GICS Sector

Euro. Telecommunication Services ROEEuro. Telecommunication Services ROETotal for all Euro. X UK Corporations in the Total for all Euro. X UK Corporations in the

Telecommunications GICS SectorTelecommunications GICS Sector

Sector Level Return On Equity Sector Level Return On Equity -- Telecommunications-- TelecommunicationsComparison of Europe and United StatesComparison of Europe and United States

-21.03-10

-5

0

5

10

15

20

25

30

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-25

-20

-15

-10

-5

0

5

10

15




-10

-5

0

5

10

15

20

25

30

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-25

-20

-15

-10

-5

0

5

10

15



Sector Level Return On Equity Sector Level Return On Equity shows a tale of two shows a tale of two

different different USUS Consumer sectors Consumer sectors

0

5

10

15

20

25

30

35

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-1

2

5

8

11

14

17

20

ROE (%) LHS

Margin (%) RHS

Financial Leverage (Ratio) RHS

Asset Turnover (Ratio*10) RHS


0

5

10

15

20

25

30

35

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-5

-2

1

4

7

10

13

ROE (%) LHSMargin (%) RHS

Financial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS

US Consumer Staples ROEUS Consumer Staples ROETotal for all US Corporations in the Total for all US Corporations in the

Consumer Staples GICS SectorConsumer Staples GICS Sector


US Consumer Discretionary ROEUS Consumer Discretionary ROETotal for all US Corporations in the Consumer Total for all US Corporations in the Consumer

Discretionary GICS SectorDiscretionary GICS Sector



Sector Level Return On Equity Sector Level Return On Equity shows a tale of two shows a tale of two

different different EuropeanEuropean Consumer sectors Consumer sectors

Euro. Consumer Staples ROEEuro. Consumer Staples ROETotal for all Euro. X UK Corporations in Total for all Euro. X UK Corporations in

the Consumer Staples GICS Sectorthe Consumer Staples GICS Sector

Euro. Consumer Discretionary ROEEuro. Consumer Discretionary ROETotal for all Euro. X UK Corporations in the Total for all Euro. X UK Corporations in the

Consumer Discretionary GICS SectorConsumer Discretionary GICS Sector

-5

0

5

10

15

20

25

30

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

-5

0

5

10

15


0

5

10

15

20

25

30

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

0

5

10

15


ROE in % ROE in % Component Ratios Component Ratios



A) Improvement in Profit Margins remains the most likely source of near term earnings growth:

Interaction among operating leverage, capacity utilization, profit margins Much operating cost reductions already achieved Many sectors will need growth in CapEx to generate high margins

B) Financial Re Structuring has been in vogue, but will markets allow for greater Financial Leverage?

CapEx increasingly funded with retained earnings Return on Investment receives greater scrutiny by investors Raising the profile of net income relative to current operating profits

C) Asset Turnover (efficiency) is at low point, there is room to rise, but long term trend is down

Already quite a lot has been accomplished in asset re pricing, impairment write-offs, funding at low interest rates

Some sectors showing recent pickup in asset turnover Yet any sizeable increase in M&A and CapEx will limit room for

improvement in asset efficiency

How Will Corporate ROE Rise From Here?How Will Corporate ROE Rise From Here?

Source: WIS World Industry ServiceSource: WIS World Industry Service


A) Will Profit Margins Rise in Key Growth Sectors?A) Will Profit Margins Rise in Key Growth Sectors?Technology and Financial Sectors in US and EuropeTechnology and Financial Sectors in US and Europe

-5

0

5

10

15

20

25

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

United StatesUnited KingdomEurope (X UK)

Operating Profit Margin for All Operating Profit Margin for All

Companies in the Companies in the FinancialFinancial SectorSector

Operating Profit Margins Operating Profit Margins (Excludes Depreciation & Write Offs) (Excludes Depreciation & Write Offs) (Comparison between US, UK and Continental Europe)(Comparison between US, UK and Continental Europe)

-10

-5

0

5

10

15

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

United StatesUnited KingdomEurope (X UK)

Operating Profit Margin for All Operating Profit Margin for All

Companies in the Companies in the TechnologyTechnology SectorSector



A) The Consumer Oriented Sectors Have Enjoyed a A) The Consumer Oriented Sectors Have Enjoyed a Steadier Profit Margin PerformanceSteadier Profit Margin Performance

0

5

10

15

20

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Health CareConsumer StaplesConsumer Discretionary

Operating Profit Margin for Operating Profit Margin for All All EuropeanEuropean (X UK) (X UK) Companies in Companies in Health Care, Consumer Staples and Health Care, Consumer Staples and

Consumer DiscretionaryConsumer Discretionary

Operating Profit Margins Operating Profit Margins (Excludes Depreciation & Write Offs) (Excludes Depreciation & Write Offs) (Comparison between US and Continental Europe)(Comparison between US and Continental Europe)

0

5

10

15

20

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Health CareConsumer StaplesConsumer Discretionary

Operating Profit Margin for Operating Profit Margin for All All U.S.U.S. Companies Companies in in Health Care, Consumer Staples and Health Care, Consumer Staples and

Consumer DiscretionaryConsumer Discretionary



A) Will Profit Margins Rise in Key Growth Sectors?A) Will Profit Margins Rise in Key Growth Sectors?Technology and Financial Sectors in US and EuropeTechnology and Financial Sectors in US and Europe

0

5

10

15

20

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

TelecomsIndustrialsMaterials

Operating Profit Margin for Operating Profit Margin for All All EuropeanEuropean (X UK) (X UK) Companies in Companies in Materials, Industrials, and TelecomsMaterials, Industrials, and Telecoms

Operating Profit Margins Operating Profit Margins (Excludes Depreciation & Write Offs) (Excludes Depreciation & Write Offs) (Comparison between US and Continental Europe)(Comparison between US and Continental Europe)

0

5

10

15

20

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

TelecomsIndustrialsMaterials

Operating Profit Margin for Operating Profit Margin for All All USUS Companies in the Companies in the Materials, Industrials, and TelecomMaterials, Industrials, and Telecom Sectors Sectors



How Do Sector Profits Change with Sales Growth? Sector Beta Relating Operating Profits to Sector Sales Growth, Where a Number Above 1 Shows Higher Sector Beta Relating Operating Profits to Sector Sales Growth, Where a Number Above 1 Shows Higher

Leverage, Below 1 Shows Lower Leverage (1992-2002)Leverage, Below 1 Shows Lower Leverage (1992-2002)

A) Sector Operating Characteristics:A) Sector Operating Characteristics:Degree of Operating LeverageDegree of Operating Leverage

Degree of Operational Leverage (DOL) summarizes how changes in sales growth affect profits growth

DOL reflects mix of fixed costs versus variable costs in operations

Sectors with high fixed costs and CapEx Requirements have higher DOL

DOL is often higher in U.S. than in ROW

DOL in U.S. has been on a rising trend 0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

To

tal

En

erg

y

Ma

teri

als

Ind

us

tria

ls

Co

ns

um

er

Dis

cre

tio

na

ry

Co

ns

um

er

Sta

ple

s

He

alt

h C

are

Fin

an

cia

ls

Info

rma

tio

nT

ec

hn

olo

gy

Te

lec

om

s

Uti

litie

s

US World Excluding US



B) How Much Financial Leverage Will Markets Allow?B) How Much Financial Leverage Will Markets Allow?

1.5

2

2.5

3

3.5

4

4.5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003 0.5

1

1.5

Interest Expense as % of Total ExpenseFinancial Leverage Ratio (Asset/Equity)Ratio of Debt to Equity (RHS)

1.5

2

2.5

3

3.5

4

4.5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003 0.5

1

1.5

Interest Expense as % of Total ExpenseFinancial Leverage Ratio (Asset/Equity)Ratio of Debt to Equity (RHS)

EuropeanEuropean (X UK) (X UK) Totals for All Non Totals for All Non Financial Corporations in the GICS Financial Corporations in the GICS

Sector Classification SchemeSector Classification Scheme

USUS Totals for All Non Financial Totals for All Non Financial Corporations in the GICS Sector Corporations in the GICS Sector

Classification SchemeClassification Scheme

Measures of Financial LeverageMeasures of Financial Leverage(Financial Multiplier, Gearing Ratio and Interest Expense Ratio)(Financial Multiplier, Gearing Ratio and Interest Expense Ratio)


D/E On RHS Scale


B) Which Sectors have the Highest Gearing Ratio? B) Which Sectors have the Highest Gearing Ratio? Sector Ratio of Debt to EquitySector Ratio of Debt to Equity

0.5

1

1.5

2

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

TelecomsConsumer DiscretionaryUtilitiesIndustrials

European Sectors with High Debt to Equity RatiosEuropean Sectors with High Debt to Equity Ratios US Sectors with High Debt to Equity RatiosUS Sectors with High Debt to Equity Ratios

Sector “Saints” and “Sinners” with Financial LeverageSector “Saints” and “Sinners” with Financial Leverage(Gearing Ratio: Ratio of Debt to Equity)(Gearing Ratio: Ratio of Debt to Equity)

0.5

1

1.5

2

2.5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

TelecomsConsumer DiscretionaryUtilitiesIndustrials



B) Which Sectors have the Highest Gearing Ratio? B) Which Sectors have the Highest Gearing Ratio? Sector Ratio of Debt to EquitySector Ratio of Debt to Equity

0

0.5

1

1.5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Health CareMaterialsEnergyConsumer Staples

European (X UK) SectorsEuropean (X UK) Sectors US SectorsUS Sectors

Sector “Saints” and “Sinners” with Financial LeverageSector “Saints” and “Sinners” with Financial Leverage(Gearing Ratio: Ratio of Debt to Equity)(Gearing Ratio: Ratio of Debt to Equity)

0

0.5

1

1.5

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Health CareMaterialsEnergyConsumer Staples



C) Asset Turnover Measures Asset EfficiencyC) Asset Turnover Measures Asset Efficiency

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Europe (Excluding UK)United KingdomUnited States

Asset Turnover for All Companies in Asset Turnover for All Companies in FinancialFinancial Sector in the US, UK and EuropeSector in the US, UK and Europe (X UK) (X UK)

Asset Turnover for Asset Turnover for All CompaniesAll Companies in the in the GICS Listing for US, UK and EuropeGICS Listing for US, UK and Europe (X UK) (X UK)

How Much Sales do Balance Sheet Assets Generate?How Much Sales do Balance Sheet Assets Generate?


0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003



C) Asset Turnover Measures Asset EfficiencyC) Asset Turnover Measures Asset Efficiency

0.2

0.4

0.6

0.8

1

1.2

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

US TechnologyEU (Excluding UK) TechnologyUS TelecomsEU (Excluding UK) Telecoms

0.2

0.4

0.6

0.8

1

1.2

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003


Asset Turnover for All Companies in Technology Asset Turnover for All Companies in Technology and Telecommunication Sectors for US and and Telecommunication Sectors for US and

EuropeEurope (X UK) (X UK)

Asset Turnover for All Non Financial Asset Turnover for All Non Financial Companies for US, UK and EuropeCompanies for US, UK and Europe (X UK) (X UK)

How Much Sales do Balance Sheet Assets Generate?How Much Sales do Balance Sheet Assets Generate?



0 1 2 3 4 5 6 7 8

Utilities

Consumer Staples

Energy

Materials


Total

Telecommunication Services

Industrials

Financials


Health Care

Percent Growth of US $ Sector Profits

Percent Growth of EU EURO Sector Profits

Rank of US GICS Sector Profits GrowthRank of US GICS Sector Profits Growth

Long Term “Normalized” Sector Profits GrowthLong Term “Normalized” Sector Profits Growth(Average Percent Growth of Operating Profits in the US, Forecast for 2004-2009, Top 10 GICS Economic Sectors)(Average Percent Growth of Operating Profits in the US, Forecast for 2004-2009, Top 10 GICS Economic Sectors)



Thank you!Thank you!

Mark Killion, CFAManaging Director

World Industry ServicesGlobal Insight, Inc.Global Insight, Inc.

Phone: 610 490 2547email: [email protected]

Documents

Copyright ©2004 Global Insight, Inc. Outlook for Corporate Profits Which are the Leading Sectors? Mark Killion, CFA Managing Director May 26, 2004