Companies in the Standard & Poor's 500 Index are paying less in interest on debt than any time in at least a decade, leaving investors more dependent on economic growth and corporate spending for equity gains in 2013.
Constituents of the benchmark gauge for American stocks such as Exxon Mobil Corp. and Walt Disney Co. cut interest expenses to 2.39 percent of sales in the 12 months ended Sept. 30 on average, the lowest level since at least 2002, according to data compiled by Bloomberg and Strategas Research Partners. With borrowing expenses at record lows, executives are finding it harder to squeeze costs, causing profit margins to contract for the first time since 2009.
Bears say projected revenue growth of 3.8 percent for S&P 500 companies next year won't be enough to drive higher profits without a decline in expenses. Bulls point to 8.9 percent profit growth estimated for next year, equity valuations at a 12 percent discount to the six-decade average and an economic recovery as reasons chief executive officers will start to spend the $1 trillion in cash they've built up since the recession.
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"The consensus view is there's not much more room for margin expansion," Nick Sargen, who oversees $43 billion as chief investment officer at Fort Washington Investment Advisors in Cincinnati, said in a phone interview. "If we've plateaued on profit margins, then the case has to be that profit growth going forward is more a function of the overall growth rate of the U.S. and global economy."
Stocks rose last week as U.S. payrolls topped economists' forecasts and unemployment slipped to the lowest level since December 2008, overshadowing the debate on preventing more than $600 billion of automatic tax increases and spending cuts in January. The S&P 500 increased 0.1 percent to 1,418.07, bringing its 2012 advance to 13 percent. Futures on the index fell 0.2 percent at 9:40 a.m. in London today.
Exxon, the world's largest oil company by market value, has seen its average interest coupon payment fall to 6.1 percent from 7.8 percent at the end of 2009, data compiled by Bloomberg show. The Irving, Texas-based company's profit margin rose to 9.3 percent from 7.7 percent in the same period, data show.
Disney sold a record amount of debt last month at the lowest interest cost it has ever paid. The world's largest entertainment company's average coupon rate last quarter fell to 3.3 percent from 5.7 percent in 2009, and the $3 billion of bonds issued Nov. 27 offer coupons ranging from 0.45 percent to 3.7 percent. Shares of the Burbank, California-based company rose 1.2 percent the day after it issued the bonds, extending its 2012 gain to 31 percent.
Declining Expense
Interest expense at S&P 500 companies has been declining for the past three years after the Federal Reserve cut its benchmark lending rate to near zero in December 2008. Lower costs have helped profits climb for 10 straight quarters, surpassing analyst estimates every quarter this year, data compiled by Bloomberg show.
American earnings will increase 8.9 percent next year and 12 percent in 2014, according to more than 11,000 analyst estimates compiled by Bloomberg. Gross domestic product is projected to expand by 2 percent and 2.8 percent, respectively, the median forecast in a survey of economists by Bloomberg.
"Revenues need to accelerate to boost margins at this point," Timothy Ghriskey, the chief investment officer at Solaris Group LLC, which manages about $2 billion in Bedford Hills, New York, said in a Dec. 6 phone interview. "And what drives margins is the economy. Do we need the economy to pick up? Absolutely."
President Barack Obama has said U.S. growth depends on lawmakers avoiding the so-called fiscal cliff because once CEOs know policies on taxes and government spending plans, they can begin to reinvest. S&P 500 companies have hoarded cash for four years, pushing the amount to a record $1 trillion for the first time at the end of 2011, S&P data show.
"The thing they're most concerned about is making sure that consumer confidence stays strong," Obama told Bloomberg Television on Dec. 4. "What they tell me is: We are ready to invest and we're ready to hire, but we want a little bit of certainty out there."
William R. Johnson, CEO at H.J. Heinz Co. in Pittsburgh, told analysts during the company's last earnings call that he wasn't ready to forecast higher earnings because the possibility of a budget impasse damps the potential for growth.
Ketchup Maker
While the largest ketchup maker has exceeded profit projections since 2011, Johnson reaffirmed his fiscal 2013 forecast, citing uncertainties about the U.S. budget, China and consumer confidence during the Nov. 20 call. The stock is down 0.8 percent since reporting earnings that beat analyst projections and the margin rose to its highest since 2009.
"We're dealing with a world right now that we can't figure out," he said. "So right now we're sort of sitting pat until we get a better sense, certainly as we approach the end of this calendar year and into the beginning of next calendar year, how all this stuff unfolds."
As executives have benefited from lower interest rates, they've also spent the past four years firing workers to keep earnings expanding. Citigroup Inc. said last week it was eliminating more than 11,000 jobs as it attempts to improve productivity. The plan will save $900 million in 2013, the New York-based company said. Many of the biggest banks have announced job cuts as they target compensation, their biggest non-interest expense.
Cash levels and rising corporate spending on capital goods are signs that stocks are spring-loaded to rally should the economy match forecasts, said Brian Barish, who helps oversee about $7 billion as president and chief investment officer of Denver-based Cambiar Investors LLC.
Capital expenditures rose 38 percent from June 2010 through the end of the first quarter, the fastest rate since June 2006, data compiled by Bloomberg show. The S&P 500 price-earnings ratio of 14.5 is 12 percent below its average since 1954. The valuation may help takeovers in 2013 climb from the $490 million announced this year, according to Barish.
"The opportunity for highly accretive cash-based M&A is quite substantial," he said in a Dec. 6 e-mail. "I see profit growth as slow and steady and unspectacular for the next couple of years."
The drop in borrowing costs helped push S&P 500 margins to 13.6 percent last quarter, compared with 8.3 percent in the same period of 2009, data compiled by Bloomberg show. After expanding almost every quarter since 2009, they have reached a level that has historically represented peaks, according to Jason Trennert, chief investment strategist at Strategas in New York.
Interest Rates
"It's hard to imagine the interest rate environment getting much more favorable," he wrote. "The Street's lofty EPS estimate for next year must be substantiated by margin expansion, strong top-line growth, or a combination of both. In an environment of peaking margins and 4 percent nominal GDP growth, it's tough to see how we'll get there."
Companies such as Dynegy Inc., the fifth-largest U.S. power generator, are using low rates to cut interest payments. The Houston-based company is refinancing $1.3 billion of loans and seeking to wipe out its debt next year. Lower interest expenses may help Dynegy avoid losses after it went into bankruptcy a year ago.
CBS Corp.'s interest expense fell to $95 million from $110 million a year ago, after refinancing, the New York-based company said last month. The profit margin for the owner of the most-watched TV network reached 12.3 percent earlier this year, the highest since 2006, data compiled by Bloomberg show.
"Most companies have been reluctant to make investments beyond what they need currently to satisfy demand," Bruce McCain, chief investment strategist at the private-banking unit of KeyCorp in Cleveland, said in a Dec. 6 phone interview. His firm oversees $20 billion. "They want to get some greater clarity as to what their cost structure will look like."
Bloomberg News
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