THE OUTLOOK FOR 22 INDUSTRIES From automobile manufacturers to steelmakers to telephone companies, the winners far outnumber the losers as this low-key expansion acquires legs.
(FORTUNE Magazine) – MORE and more companies are starting to see a payoff from their struggle to adapt to the new economy. So while this expansion doesn't look at all like the rip-roaring ones of yore, and though America's major trading partners remain stalled, prospects -- and profits -- are rising for most of the industries on these pages.
-- Aerospace: Riding out the storms. ''It wasn't a good year for us,'' allows economist David Vadas of the Aerospace Industries Association, ''and we expect the same in 1994.'' With both defense and civilian business in downdrafts, sales will fall to about $116 billion, down $22 billion over the past two years. Defense outlays will slide through 1996. Exports will help a bit, as will modest growth in the commercial market for satellites and launches. Yet profits hit an all-time high of $5.5 billion in 1993 and will continue to gain modestly. The industry has shed 30% of its employees since 1989, says Vadas, with 131,000 lost in 1993 alone. Employment is down to some 900,000, and there isn't much room for further drastic pruning, but other cost-cutting efforts will proceed.
Civilian aircraft manufacturers are working down their backlogs, so production rates are slowing. As are profits: Security analyst Cai von Rumohr at Cowen & Co. says Boeing's will fall from $1.2 billion in 1993 to $715 million in 1994. But by 2000, airlines will have to replace much of their obsolescing fleet to meet federal noise standards. Boeing will bring out a new version of the 737 in 1997, launching it with a big order from aggressively expanding Southwest Airlines.
-- Airlines: Cleared for takeoff. Three years and $10 billion of operating losses have ended. The coming year should produce net profits of as much as $1 billion, says Kevin Murphy, Morgan Stanley's airline analyst. Traffic will be up about 6%, and the carriers are finally getting capacity under control -- until recently they were still receiving planes ordered before the recession. With less discounting of seats, Murphy expects revenues to increase 10%. Unit costs, he says, will rise only 1% as the industry leaders respond to low-cost competitors. American has retreated from business it couldn't profitably handle by turning over some gates and routes at its San Jose, California, hub to Reno Air, linking the newcomer to its reservation system and frequent flier program. The big boys are trying everything to cut costs -- layoffs, outsourcing, labor confrontations, and other drastic measures. United hopes to give employees an ownership stake in return for major changes in work rules and compensation.
-- Automobiles: Still accelerating. After climbing back from a wretched 12 million units in 1991 -- the lowest since 1983 -- sales of cars and light trucks hit nearly 14 million in 1993. FORTUNE looks for 14.7 million in 1994 and a half million more in 1995. Analyst Ronald Glantz of Dean Witter says that 25% of all vehicles on the road today are at least 12 years old and ripe for replacement. And despite an average price of nearly $18,000, he argues, new cars are effectively cheaper than they have been in many years. Because of low interest rates and rising incomes, the average monthly payment is only 10.4% of median family income, vs. 11.4% during the Eighties.
Many customers are moving up to more profitable products, including pickups, minivans, and sport utility vehicles. Japan's slight competition in the truck segment is bound to grow as the Japanese build more in the U.S. -- including both cars and trucks -- but meantime Detroit is in the driver's seat. It all adds up to one of the more dramatic profit swings for any industry in recent history. In 1992 accounting changes piled paper losses on top of the Big Three's real losses, producing $30 billion in red ink. The past year produced net profits of only $2 billion or so. ''In 1994,'' Glantz says, ''the industry will start setting records again -- this time for profits.'' He looks for net earnings to total $12 billion in 1994, $16 billion the year after, and more than $22 billion in 1996.
-- Banks: Back to reality. Falling interest rates gave them easy profits for the past few years, which they used to build reserves against their rich portfolios of bad loans. Now the interest rate decline has ended, and making money the old-fashioned way will not be so easy. George Salem, an analyst at Prudential Securities, sees commercial loans producing ''disappointing growth, or none, during 1993 and 1994.'' Corporate customers are turning to nonbank sources, from the bond and equity markets to internal cash flow. Earnings for the 19 leading banks Salem tracks increased by some 25% in 1993, but for the coming year he sees a more modest 9% gain. So what's a bank to do? Keep costs under control. Consolidate through mergers. Push fee-based services such as mutual fund sales -- one reason Mellon Bank plans to buy Dreyfus Corp. Salem thinks mutual fund assets could exceed domestic bank and thrift retail time deposits any day now. And -- would you believe? -- make real estate loans. Stan Ross, the managing partner at the Kenneth Leventhal & Co. accounting and consulting firm, says banks have successfully managed the worst problems out of their portfolios. In 1994, he predicts, they will start working with survivors of the shakeout who can show good records and strong balance sheets.
-- Chemicals: Hanging in. Here's one reason people call it the new economy. William Young, an analyst at Donaldson Lufkin & Jenrette, expects chemical capacity utilization to rise to about 87% from the current 84%. ''In the past that rate would have been enough to start some action in prices,'' he says, ''but not in the low-inflation environment today.'' Operating margins, about 9.5% in 1993, will creep up to 10.2% in 1994, compared with a typical 16% when the industry neared past peaks. A European recovery that hits its stride in 1995 could help lift revenues 7% or even 8%, leading the way to a profit peak later in the decade. Dow and Du Pont would particularly benefit. Competing in probably the most globalized of the major manufacturing industries, U.S. producers cook up powerful exports. Though rising imports have shrunk the industry's trade surplus since the recession, the Chemical Manufacturers Association reports that exports for 1993 set another record, nearly $45 billion. Latin America will help them grow 5% this year. Taking exports, domestic shipments, and output from overseas plants together, Young expects volume and revenues to increase by some 5%. The industry may be able to get another percentage point of revenues from price increases.
-- Computers: Crashing profit margins. It gets tougher and tougher to make a living building PCs. Vice president John Gantz of International Data Corp. says unit shipments for 1993 were up 26%, and will rise another 10% in 1994. But price wars are savaging profits. Barry F. Bosak of Smith Barney Shearson estimates that gross margins for Apple, Compaq, Dell, and AST will range from 19% to 27% in 1994 -- vs. 32% to 47% in 1991. Says Bosak: ''The battle continues until some companies go out of business.'' Another fight is brewing over central processor chips. PowerPC, a new entry developed jointly by Apple, IBM, and Motorola, coming in major products to be introduced in 1994, outperforms Pentium and could nibble a bit of Intel's market share over the next few years, says Chris Goodhue of the Gartner Group. But he doesn't expect any challenge to Intel's dominance. Boxed software sets called suites are souring the profit margins of desktop software makers. Gartner's Carter Lusher says these low-priced packages of popular applications can cut profit margins some 80%. The dominant player is -- who else? -- Microsoft. And anything that includes the word ''network'' is hot. Morgan Stanley principal George Kelly says he recommends networking specialists Novell, Cisco, SynOptics, and 3COM.
-- Electronic Media: Tuned in. Broadcasting revenues will get help in 1994 from the Winter Olympics and the fall elections. John Suhler of the Veronis Suhler & Associates investment banking firm says ad sales should grow 7.5% in 1994 after a modest 3.3% increase in 1993. Cable's ad revenues will climb more than 13% in both 1993 and 1994, but the total will still come to less than $2.8 billion in 1994 -- vs. $28.6 billion for broadcast TV. Re-regulation means that cable fee revenues won't grow for the next couple of years, but will hold at just over $17 billion -- a shock compared with the historical double-digit growth rate. For many years the two industries seemed ready to fight to the death as cable tore away market share from the networks. But for the past 18 months or so broadcasting market share has held steady or increased. New cable networks have simply cannibalized older ones. Now, Suhler says, ''the two media are figuring out how to co-exist.'' He believes that networks will remain the mass medium for entertainment, and local broadcasters the medium for local news. Cable will serve specialty audiences and the advertisers trying to reach them.
-- Financial Services: Interest sensitive. With the end of falling interest rates, says analyst Guy Moszkowski at Sanford C. Bernstein, Wall Street will kiss record earnings goodbye -- though the brokerages will remain strong from individual investors. Profits will come from managing stock, bond, and money market mutual funds. The industry grew to control $2 trillion of assets in 1993 -- double the amount of 1990. For credit card issuers, the equation is a bit more complex. The lower rates they paid on borrowed money helped offset the losses from customers who fell behind during the recession. Many issuers hope to raise the rates they charge when those they pay start up again, but competition may keep that from happening. Meantime, says Moszkowski, return on equity has dropped from the astonishing 40% rate of the mid-Eighties to a still lush 25% or so. He thinks it will plateau around 20%, and expects American Express and Dean Witter, Discover & Co. to thrive.
-- Foods: Lean cuisine. Their confidence may be rising, but consumers will stay tightfisted. ''They don't want to buy anything unless it's on sale,'' says Lawrence Adelman, an analyst at Dean Witter. And private-label products continue to lure them. Nevertheless, Adelman predicts 9% operating profit growth in 1994 for the ten food processors he covers. Earnings took a hit in 1993 from the corporate tax increase, he says, and restructurings will start to pay off in the coming year with lower costs. He expects revenues to be up 2% to 4% on the domestic side and 4% to 6% internationally. Cereal makers should get a lift from the aging and health-conscious, he adds. And assuming the Mexican economy strengthens because of NAFTA, PepsiCo and Coke ''will be major beneficiaries.''
-- Forest Products: Green. If a tree grows in Brooklyn, the New York City borough might consider planting more. ''Lumber prices are soaring like an eagle,'' says Joshua Zaret, an analyst at Nomura Research Institute. ''They were up 35% in 1993 and will rise another 15% to 20% in 1994.'' Demand is surging along with homebuilding, but supplies are tight. Federal lands hold more than 40% of the country's softwood timber inventory, but ''Uncle Sam no longer sells timber off national forests in the Pacific Northwest and has curtailed sales elsewhere,'' explains Con Schallau, an economist with the American Forest and Paper Association.
-- Health Care: A dose of disinflation. The market-driven reforms that have cut health cost increases from 9.1% to a recent 4.2% since 1990 (are you listening, Mr. President?) show no sign of ending. As providers continue to consolidate, says Donaldson Lufkin & Jenrette analyst John Hindelong, ''the result will be fewer employees, fewer services, and fewer locations -- a more streamlined health care system.'' Well-managed hospitals will prosper, he says. Nursing homes will also do well, but niche providers, such as surgery centers, will suffer slower growth and pressure on profit margins. For nursing homes and other long-term-care facilities, analyst Deborah Lawson of Alex. Brown & Sons forecasts 15% to 30% earnings-per-share growth in each of the next two years. HMOs are gaining by offering more choice and flexibility, says Eleanor Kerns, also at Alex. Brown. She looks for nationwide enrollment -- she estimates HMOs currently serve about 20% of the population -- to grow 8% to 10% in 1994. The hotter performers among the companies she covers, among them Oxford Health Plans, PacifiCare Health Systems, and US Healthcare, should enjoy earnings-per-share growth of 20% to 45%.
-- Hotels: Room for profits. With excess capacity built during the Eighties finally under control, occupancy rates are climbing. Roger Cline, worldwide director of Arthur Andersen & Co.'s hospitality consulting services, estimates that the rate was about 64% for 1993, not far from the pre-recession peak, and will hit 65.5% next year. Interest payments have fallen as lenders have eaten losses on the industry's troubled operations. So even though room rates are not keeping up with inflation, hoteliers, who barely broke even in 1992, made operating profits of $3.3 billion in 1993. Since fixed costs are high, incremental revenue can fall to the bottom line, and Cline forecasts that profits will nearly double in 1994. The trend has staying power, he adds. Demand for rooms will increase at four times the rate of new supply into 1996. Except in such places as Las Vegas and the Disney resorts at Orlando, Florida, few new rooms are under construction.
-- Housing: Raising the roof. Coming off its best year since 1987, the industry still has room before it bumps up against the rafters. That's good news for the expansion: Healthy homebuilding spurs sales of refrigerators, washing machines, furniture, and other goods. Says a cheerful Neil Cline, manager of industry forecasting at GE Appliances: ''Every time a new home is built, roughly 3.5 core appliances get sold.'' FORTUNE estimates that starts of single-family homes reached 1.1 million in 1993. In 1994 they should edge up to 1.2 million. Mortgage rates have climbed a bit since fall, but they're still low -- one reason buying a home is more affordable now than it has been in almost 20 years. Existing-home sales will edge up to 3.8 million units in 1994, says the National Association of Realtors. Even the sluggish multifamily market may have bottomed out. The National Association of Home Builders projects some 200,000 starts in 1994, wimpy beside the 600,000 of the mid-1980s but 26.7% higher than in 1993.
-- Industrial Equipment: Keeping the momentum. As business continues its capital spending splurge, FORTUNE expects sales to rise close to 10% in 1994 before slowing to under 5% in 1995. Paine Webber analyst Eli S. Lustgarten says that the homebuilding and infrastructure surges lifted construction equipment sales 15% in 1993 and will help keep up a 5% to 10% rate through 1995. Heavy-truck sales, 1993's success story, will downshift to a still- respectable pace as pent-up demand is sated. CS First Boston analyst John E. McGinty predicts sales of 185,000 rigs, up about 6%, after a 30% increase in 1993. The biggest drag on industrial equipment comes from stagnant overseas markets. J. Keith Dunne, vice president of the investment firm Robert W. Baird, says pockets of strength in Latin America and the Pacific Rim do not offset the luffing in Europe and Japan. The WEFA Group consulting firm expects export sales to rise less than 5%.
-- Insurance: Time to reengineer. Earnings on investments are declining, exposing an unhappy truth. Put bluntly, says Robert Lackey, who heads the insurance practice at Gemini Consulting, ''this whole industry has a cost problem.'' Insurance is increasingly a commodity business. Low-cost providers will make money, as will some well-focused niche players like Chubb, AIG, USAA, and a few small life insurers. For most, the challenge will be to reduce expenses without disrupting service -- in a culture where the implicit reward for low pay has been almost a guarantee of lifetime employment. Crucial functions like claims processing and adjusting, for example, have what Lackey calls ''high touch'' characteristics -- hard to provide if your employees are disgruntled.
Property and casualty insurers have extra headaches. They are still reeling from the $17 billion in damages Hurricane Andrew wreaked over a year ago, which helped drive their 1992 catastrophe claim payments to a record $23 billion ($2 billion to $3 billion was typical during the 1980s). More sobering was what could have happened if Andrew had hit Miami dead on. Sean Mooney of the Insurance Information Institute calculates that the resulting claims of $40 billion to $50 billion would have bankrupted many companies. Feebly trying to cushion itself against such a disaster, the industry is nudging up prices -- premiums rose more than 5% in 1993, says Mooney, vs. about 2% in 1992, and are likely to climb 6% to 7% in 1994.
-- Metals: Mostly gains. Steelmakers will finally get a payoff from the hard work that made them into some of the world's low-cost producers. J. Clarence Morrison, a metals analyst with Prudential Securities, anticipates ''an earnings explosion'' among the seven U.S. companies he follows, from a combined loss of nearly $560 million, excluding write-offs, in 1992 to profits of $800 million in 1994 and nearly $1.5 billion in 1995. Imports are low and order books strong. The result, says John Jacobson of the WEFA Group consulting firm: Steelmakers lifted prices nearly 5% in 1993 and could get another 5% in 1994. Capacity utilization will be 85% or better. Many minimills aren't so mini anymore: Nucor is likely to end 1994 as the country's fourth-biggest steelmaker, and its sales could hit $3 billion in 1995. But minimill profits may lag behind revenue growth: Prices of scrap, the raw material for their electric furnaces, swelled 50% in the past year. Copper, too, should shine. Morrison says demand will exceed supply in 1994 for the first time in a couple of years. Prices averaged 83 cents a pound for 1993 and should climb to about $1 in 1995. Demand is strong in North and South America and in all of Asia except Japan. Copper's largest single market is the miles of wiring in the motors that drive assembly lines; when factories hum, Morrison points out, that wiring needs more frequent replacement. Aluminum is still struggling with overcapacity. About 40% of the world's production is from companies that are partly or wholly owned by governments willing to operate at a loss to preserve jobs -- and the former Soviet Union, desperate for hard currency, is practically giving the stuff away.
-- Oil and Gas: On a slippery slope. Petroleum Industry Research Foundation Chairman John Lichtblau estimates that global demand fell 0.3% in 1993 and should gurgle up just 1.6% in 1994. Despite a worldwide oil surplus, OPEC hasn't been able to get its act together. A barrel of West Texas intermediate crude now costs about $14.50, the lowest price in real terms since 1974. These prices are bad news for the profit margins of any petroleum company without significant refining operations, says Kidder Peabody analyst Bernard Picchi. Picchi thinks prices will linger between $13 and $17 for the near future. The cartel notwithstanding, Picchi explains, exploration and development costs determine the ultimate price of oil, and these have fallen from $10 a barrel a decade ago to about $5 because of technological advances and the opening of reserves in places like Vietnam, Russia, Yemen, and China. Natural gas prices will bubble. Amoco chief economist Ted Eck says that worldwide demand has been growing at a 2% to 3% rate, outstripping supply. ''We're going to have to work our reservoirs harder,'' he says. ''The more people want clean air, the more they want natural gas.'' Picchi expects prices, now around $2 per thousand cubic feet, to remain ''solidly above'' $2 to $2.20 for the next two years.
-- Paper: Soft. Prices will recover modestly from their five-year plunge. Newsprint and linerboard -- used in corrugated packing boxes -- hold the most promise; capacity is not greatly in excess, and demand has turned up. Still, says Larry Ross at Paine Webber, ''any comeback will start at the bottom and be subject to the below-average recovery.'' The industry is getting no help from Washington, which accounts for 2% of U.S. sales. President Clinton's October decree that the bureaucracies must start using recycled paper will force new investment, especially if state and local agencies follow the federal lead.
-- Pharmaceuticals: Needled. HMOs and other managed-care plans, which favor generics and lower-priced brand-name drugs, will continue to chip away at prices. Analyst Jack Lamberton of NatWest Securities predicts earnings per share for the ten brand-name drugmakers he follows will grow only 4% for the year as a result. By contrast, he expects earnings for his five generic manufacturers to climb 39%. International revenue growth for branded manufacturers will come from Latin America, Africa, and the Middle East, says analyst Scott Shevick at Bear Stearns. But governments in Europe are putting pressure on prices. And, says Ronald Nordmann of Paine Webber, that will soon happen in Japan and possibly Canada. Other bad news for 1994 includes a reduction in the tax benefit to companies that manufacture in Puerto Rico and patent expirations for many drugs, from Marion Merrell Dow's Seldane, an allergy medication, to Ceclor, an antibiotic from Eli Lilly.
-- Railroads and Trucking: On track. As the economy rolls ahead, so will those who deliver the goods. The railroads are lean and will get leaner, says Lehman Brothers analyst Burton M. Strauss. He expects employee reductions on the order of 2% to 4% a year for the next five years. The trouble with trucking is too few employees. Driving, says John Larkin, an analyst at Alex. Brown, ''is a fundamentally crummy job,'' especially when a surge in housing starts offers better construction employment. Companies that have the people, like Swift Transportation and Heartland Express, could see 20% to 25% revenue growth over the next two years, with help from lower fuel costs and impending rate increases. The generally good outlook for regional less-than-truckload carriers is clouded by a tough contract battle with the Teamsters early in the year.
-- Retailing: Looser purse strings. Consumers will spend around 6% more next year in stores, catalogues, and other venues, forecasts Morgan Stanley analyst Bruce Missett. Besides personal-income and employment gains, he credits a feeling of security among layoff survivors who feel ''they've dodged the bullet.'' But that doesn't mean it's fat city for merchants. Customers will remain value-conscious. ''We don't foresee any explosion of consumer confidence,'' says Stephen Latz, an analyst at A.G. Edwards. And competition will continue to be intense. In an environment of modest inflation, retailers will be fighting for sales by holding prices down. ''You can't make too many mistakes,'' says Latz. ''If you do, you're history.'' Sales of furniture, appliances, and electronics will again be strong; general merchandise will be ''moderate, somewhat ahead of inflation.'' Clothing sales, says Missett, should pick up, assuming the weather is normal and retailers offer more appealing merchandise than they did in 1993.
-- Telecommunications: 1-800-DREAM. Behind the superhype lurks an industry with merely solid performance in the here-and-now. David Yedwab of Eastern Management Group estimates that revenues moved up 5% to 8% in 1993 and should improve 6% to 9% in 1994 and again in 1995. That's why the industry is slavering over the putative rich markets along the Information Superhighway. But will the surveyors get ahead of reality, investing prematurely in the wrong projects? ''Jumping headlong into technological overhaul mode without taking care of their core businesses is hazardous to the bottom line,'' says Yedwab. And CS First Boston analyst Frank Governali questions how quickly consumers will take to the cornucopia of multimedia services soon to be available, like interactive television and videoconferencing: ''Cultural and generational changes are required for all the things that are possible to take hold.'' Nobody knows how much regional bells, cable operators, and telecom giants will have to spend on building for their brave new services -- but, says Yedwab, they'll have to start soon. That might help the equipment business, which in any case is picking up because customers are upgrading; Yedwab thinks 1994 could be its first profitable year since the AT&T divestiture ten years ago. Workaday phone operations will see healthy growth too. Governali says long- distance revenues will increase 5% to 6% this year, fueled in part by the explosion of wireless service. The number of cellular subscribers, he says, has been growing in the 35% to 40% range, and revenues in 1994 should keep up a 30% to 35% pace.
, CHART: NOT AVAILABLE CREDIT: FORTUNE TABLE/SOURCE: INDUSTRY PERFORMANCE MONITOR CAPTION: EARNINGS-PER-SHARE GROWTH Industry Performance Monitor translated FORTUNE's economic forecast into EPS growth for 28 S&P industry indexes (the 1993 figures are estimates).