The Squeeze Is On: Will It Be Enough To Tank Profits?

Pamela Huggins, vice president and treasurer at $7 billion diversified manufacturer Parker Hannifin Corp., recalls how it wasn’t until early last year that the company was convinced the recession of 2001 was really over. New orders for the Cleveland-based producer of everything from aerospace equipment to refrigeration devices were mostly flat until early 2004, some 18 months after the official end of the recession. Then, business took off like a rocket. “We really had a tremendous ramp-up,” says Huggins, with year-over-year order spikes between 20% and 30% across many divisions, and similar growth into this year. At the same time, an earlier overhaul of Parker’s procurement and manufacturing methods toward leaner, lower inventory approaches chopped operational costs, pushing profit margins to near record levels. The newfound efficiency also allowed Parker Hannifin to cut its capital spending as a percent of sales dramatically, from 5.1% in 1998 to about 1.9% this year. The result: record cash flow.

It’s been a long time coming, but from earnings to margins to investment spending, the U.S. business sector is having its best run since the stock market meltdown that began in 2000. The performance has exceeded all but the most optimistic forecasts. A July survey by Standard & Poor’s Corp. found a record $634 billion of cash and equivalents on hand at the 376 industrial companies in the S&P 500. Even more significant, the ratio of cash to market capitalization for the group stands at 7.7%, the highest since 1988. Profit margins are back near their recent historical peaks of the late 1990s and the surge in earnings has brought with it a sharp rebound in business investment spending, which climbed 10.6% in 2004, its best rise since 1998. But as with every great party, things eventually have to wind down, and that is where the outlook is heading. Steady rises in labor and energy costs are already causing economists to ratchet down their earnings expectations for the remainder of this year and into 2006. Even at bullish Parker Hannifin, there has been a noticeable cooling off from the heady pace of orders over the last twelve months. “We’re continuing to see an increase in orders … but we’re seeing a moderation in the growth, toward more normalized growth going forward,” says Huggins.