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?
Copyright ©2004 Global Insight, Inc. 3
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10
15
20
25
30
35
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45
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60
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85
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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
Copyright ©2004 Global Insight, Inc. 4
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.
Copyright ©2004 Global Insight, Inc. 5
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
Profits as Shares of GDP (RHS)(Percent)
Source: GII World Economic ServiceSource: GII World Economic Service
Copyright ©2004 Global Insight, Inc. 6
-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
Profits as Shares of GDP (RHS)(Percent)
-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
Profits as Shares of GDP (RHS)(Percent)
Source: GII World Economic ServiceSource: GII World Economic Service
Copyright ©2004 Global Insight, Inc. 7
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
Copyright ©2004 Global Insight, Inc. 8
Which US Sectors are Generating Profits?Which US Sectors are Generating Profits?
Source: US BEASource: US BEA
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$)(Billions of US$)
Copyright ©2004 Global Insight, Inc. 9
Which US Sectors are Recovering or Stalling?Which US Sectors are Recovering or Stalling?
Source: US BEASource: US BEA
AnnualAnnual AnnualAnnualLast 8 QuartersLast 8 Quarters Last 8 QuartersLast 8 Quarters
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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$)(Billions of US$)
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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$)(Billions of US$)
Copyright ©2004 Global Insight, Inc. 10
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$)(Billions of US$)
Source: US BEASource: US BEA
AnnualAnnual AnnualAnnualLast 8 QuartersLast 8 Quarters Last 8 QuartersLast 8 Quarters
Which US Sectors are Recovering or Stalling?Which US Sectors are Recovering or Stalling?
Copyright ©2004 Global Insight, Inc. 11
-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
AnnualAnnual AnnualAnnualLast 8 QuartersLast 8 Quarters Last 8 QuartersLast 8 Quarters
Which US Sectors are Recovering or Stalling?Which US Sectors are Recovering or Stalling?
Copyright ©2004 Global Insight, Inc. 12
-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
AnnualAnnual AnnualAnnualLast 8 QuartersLast 8 Quarters Last 8 QuartersLast 8 Quarters
Which US Sectors are Recovering or Stalling?Which US Sectors are Recovering or Stalling?
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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
Copyright ©2004 Global Insight, Inc. 13
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
Copyright ©2004 Global Insight, Inc. 14
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
Copyright ©2004 Global Insight, Inc. 15
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)
Copyright ©2004 Global Insight, Inc. 16
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.
Copyright ©2004 Global Insight, Inc. 17
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
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2
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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
Copyright ©2004 Global Insight, Inc. 18
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
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5
6
7
8
9
10
11
12
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
Component RatiosROE in %
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
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
Copyright ©2004 Global Insight, Inc. 19
0 5 10 15 20 25
Telecommunication Svs.
Information Technology
Materials
Utilities
Consumer Discretionary
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
Copyright ©2004 Global Insight, Inc. 20
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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
ROE in % Component Ratios
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
Copyright ©2004 Global Insight, Inc. 21
ROE in % Component Ratios
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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
Component RatiosROE in %
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
-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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
Copyright ©2004 Global Insight, Inc. 22
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
Component RatiosROE in %
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
ROE in % Component Ratios
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 23
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
ROE (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
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 (%) LHSMargin (%) RHSFinancial Leverage (Ratio) RHSAsset Turnover (Ratio*10) RHS
ROE in % ROE in % Component Ratios Component Ratios
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 24
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
Copyright ©2004 Global Insight, Inc. 25
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 26
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 27
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 28
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
Source: GII World Industry ServiceSource: GII World Industry Service
Copyright ©2004 Global Insight, Inc. 29
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)
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
D/E On RHS Scale
Copyright ©2004 Global Insight, Inc. 30
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 31
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
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 32
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?
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
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
Europe (Excluding UK)United KingdomUnited States
Copyright ©2004 Global Insight, Inc. 33
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
Europe (Excluding UK)United KingdomUnited States
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?
Source: Worldscope Company Financial Statements & Source: Worldscope Company Financial Statements & WIS CalculationsWIS Calculations
Copyright ©2004 Global Insight, Inc. 34
0 1 2 3 4 5 6 7 8
Utilities
Consumer Staples
Energy
Materials
Consumer Discretionary
Total
Telecommunication Services
Industrials
Financials
Information Technology
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)
Source: GII World Industry ServiceSource: GII World Industry Service
Copyright ©2004 Global Insight, Inc. 35
Thank you!Thank you!
Mark Killion, CFAManaging Director
World Industry ServicesGlobal Insight, Inc.Global Insight, Inc.
Phone: 610 490 2547email: [email protected]