There’s much talk on Wall Street about US corporations struggling in the present global economic environment. But broadening the lens beyond public firms reveals a different picture.
Pre-tax profits at non-financial firms jumped at a 10.6 per cent year-over-year pace in the second quarter, according to a Goldman Sachs analysis of Federal Reserve data, which takes in more small businesses.
That compares to a drop of 11 per cent among companies listed on the S&P 500, led by energy firms.
The S&P 500 is made up of large American companies — those with a market value of at least $4 billion. For a sense of perspective, the US Census Bureau estimates there existed 5.7 million American firms with paid employees in 2012, of which only a little more than 18,000 employed more than 500 people.
Earnings growth is critically important for investors, as many economic models base a company’s value on its profits.
The New York-based investment bank reckons the divergence in the earnings picture is at least partially due to public firms’ greater exposure to moves in the US dollar and global economic demand.
The greenback has risen about 7 per cent against a basket of major world currencies this year. A rising dollar makes American goods more expensive to global markets. Oftentimes, larger multi-national firms, which often trade on public markets, are particularly impacted by such currency moves.
Meanwhile, economic growth in emerging markets has taken a hit this year. China, the world’s No. 2 economy, may see growth slow from 7.3 per cent last year to 6.8 per cent this year, according to an estimate from the International Monetary Fund. That could ricochet across the world.
Goldman said companies are still benefiting broadly from low interest rates, which have “helped release cash flow.” Indeed, net interest expenses continue falling on year-to-year basis, albeit at a substantially slower pace than even a year ago. That could be the result of firm’s taking on more interest-bearing debt.
Businesses are also making capital expenditures beyond the pace in which their current equipment is depreciating. Goldman estimates that on an adjusted basis, fixed capital expenditures net of depreciation and amortization equated to roughly 13.5 cents of every dollar of earnings before interest, taxes, depreciation and amortization (EBITDA).
“To put this figure into perspective, this is a similar pace of capital expenditure to that last seen during the second half of the previous business cycle, i.e., around 2005-06,” Goldman said in a note to clients.
Goldman also notes companies are generating “abundant” free cashflow – a key indicator of corporate profitability – to the tune of about 22 cents for every dollar of EBITDA.
We note that the trend in free cash flow generation is down from the earlier part of the recovery; for instance, we calculate that free cash flow stood as high as 35 cents in the second half of 2009 and into 2010. That said, the latest figures remain very respectable. Average free cash flow in the 2001-07 cycle was 17 cents, and corporates have been clearing that mark consistently since 2009, while maintaining high levels of net capital spending.