Corporate Australia Sees Profits Rise, Just Don’t Tell Dick Smith

‘Company profits on the rise’ is a headline that sounds like it should be good news. And in any normal, functioning economy, it would be. But Australia hasn’t been normal for years. We’re stuck in economic limbo.

One look at these so called rising profits brings up feelings of bemusement. It feels like a hollow victory, because that’s exactly what it is.

These aren’t profits driven by real growth. They’re profits built on debt and spending cuts. I’ll explain why shortly. First, the data.

In the quarter to September, gross operating profits were up 1.3%. That figure was slightly better than the 1.1% economists predicted. But the ‘good’ news didn’t end there.

Business borrowing in October rose at the fastest clip since 2009. RBA figures show lending rose for the second straight month. Business loans are up 6.6% for the year.

A breakdown of sectors shows mining profits grew by an impressive 6.1%. Amidst the worst commodity rout in living memory, that’s quite a feat. And yet, despite this, wages across mining declined 2.6%.

Elsewhere, manufacturing profits were up 4.9%. Real estate sector services also saw profits rise by 4.6%. The one black mark was the construction sector, which saw profits decline by 16.6%.

Construction aside, it all looks quite impressive, doesn’t it? Corporate Australia seems to be doing just fine. Or so it would appear.

It’s a head scratcher. Other economic indicators suggest we’re in the middle of a very difficult period. We don’t need to list them all here. But they all stem from falling mining revenues and slowing global growth.

Are profits the result of declining business spending?

Let’s get to the bottom of why profits are up.

Businesses aren’t investing, and we know that for a fact. Recent ABS figures showed third quarter business spending was down 9.2%. That was slightly better than Q2 capex, when investment fell 11.2%.

Typically, businesses have to spend to grow. As a business expands, so too do its profit margins.

Yet something doesn’t add up here. Borrowing is on the rise, but investment is plunging. How? What reason does a business have in borrowing credit? If it’s investing less on average, there’s little reason to borrow more, right?

The answer is obvious when you take a cynical view of the situation.

It’s never been easier to access credit than it is now. Borrowing has never been cheaper, because rates have never been lower. Interest rates are at 2% to encourage business lending. Everyone borrows when it’s easy and cost effective to do so. That applies to corporate Australia as much as it does to everyday Aussies.

But again, we go back to the issue of capital investment. With business spending falling, it can mean only one thing. Businesses are growing profits by cutting spending and investment.

There’s evidence to support this. Look at wages, which grew by 1% during the quarter. Wage growth is up 2.5% from this time last year. All that sounds fine until you realise that wages are growing at their slowest pace on record. Meanwhile, household purchasing power has shrunk. Wages are barely keeping up with inflation. Households are poorer, even if wage ‘growth’ suggests otherwise.

The rate of wage growth does indicate however that investment remains slack. Which throws up similar dilemmas as noted above. Businesses might be borrowing more, but they’re not spending what they borrow.

So where is all that money going? If a business borrows money and doesn’t reinvest it, where does it go? I suspect you already know the answer to that question.

The likelihood is that businesses are lavishing it on investors to curry favour. They’re embarking on stock buyback schemes. Moreover, they’re using this money to support progressive dividend yields. And investors don’t care. In fact they support anything that improves their bottom line.

In an era of low growth prospects, we should expect nothing less from businesses. In any normal circumstance, profits would account for all dividend payouts. But with revenues and profits down, companies are resorting to debt and spending cuts to achieve the same goals.

Dick Smith share prices tumble 54%

One company that hasn’t had a good day, month, or even year is Dick Smith [ASX:DSH]. The electronics retailer saw its share price fall by a barely believable 54% today. It was trading at $0.30 as of 2:30pm AEST. The Sydney Morning Herald reports:

Dick Smith shares plunged [after trading opened] after it backed away from its October profit guidance and warned of more write downs. [Dick Smith] slashed the value of inventories by at least $60 million and the stock is now down 85% since the start of the year and has a market capitalisation of just $74.5 million.

Last month, [managing director Nick Abboud] forecast a 2016 net profit between $37 million and $43 million, compared with earlier guidance between $45 million and $48 million and last year’s net profit of $43.4 million.’

Dick Smith obviously didn’t get the memo that everything was fine across corporate Australia.

Ultimately, investors may not care how corporate Australia grows profit margins. As long as they do it, anything goes.

But this way of thinking is destructive. In the long term, a company can’t maintain growth if it never invests. Corporate Australia is tightening its purse, and its profits are improving as a result. But it’s hollow growth that bodes poorly for the future.

Sooner, rather than later, this pandering to investors will come back to bite businesses. There are limits to how much corporate Australia can cut back on spending. In the long term, they’ll have to revert back to investment led growth. Until then, we can pretend that growing profits are positive, and that everything is peachy.

Mat Spasic,

Junior Analyst, Markets and Money

Slowing business investment is the latest sign of Australia’s deteriorating economic prospects. The Daily Reckoning’s Greg Canavan has warned all year that Australia’s sleepwalking into recession.

His free report, ‘Australian Recession 2015: Unavoidable’, is timely in the wake of declining investments. Business investment is down, as are government revenues. At the same time, household debt has risen to record levels. It’s a grim outlook, and one that’s likely to end in recession sooner rather than later.

But there is a silver lining in all this. You can take actions right now to protect yourself from the fallout of the coming recession.

Download your free copy today to learn how to protect your wealth from the coming crash. To find out how to download his free report right now, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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