Here’s a question for all you investors out there. What happens to company profits when an economy starts taking a turn for the worse? It’s not a trick question. The answer, as you’re no doubt aware, is that profit margins fall as revenues dry up. Some companies thrive amid the panic, but the vast majority are affected by worsening economic conditions. And when revenues drop, the first port of call for most businesses is to start cutting back on expenses.
Increasingly, this is the reality facing most major blue chip companies. Subdued economic growth is making it difficult for companies to achieve targets by expanding their investments and market shares. That’s left them relying on cost-cutting measures to grow profits and appease investors.
But hang on a minute. Wasn’t it just announced yesterday that the unemployment rate came in at a better-than-expected 6%? Wouldn’t that suggest that business conditions are primed for a return to growth?
Unfortunately, the jobs data for June may be the last good news we hear for a long time. We know this because economic data has a tendency to lag before it becomes self-evident. Poor trade, business and consumer data in the last month will only reflect on unemployment figures in the next few months.
But we don’t have to wait for official data to know where things are going. You only need to listen to what companies are saying about their future intentions. Right now, most are saying that cost-cutting is here to stay.
Cost-cutting programs are in full swing across the ASX
Companies across a broad range of sectors on the ASX200 have already enacted cost-cutting measures. Many of those that haven’t already have plans to slash costs in the near future.
The big four banks have already benefitted from major cost-cutting programs. On top of that, QBE Insurance [ASX:QBE] has plans to slash costs by $178 million over the next few years. Suncorp [ASX:SUN] similarly hopes to make savings of $170 million by 2018.
Over in the resources sector, cost-cutting has been key to arresting sliding profits. A year ago a tonne of iron ore on the market sold for roughly three times what it does now. For BHP Billiton [ASX:BHP], that makes the likelihood of posting revenues matching recent highs virtually impossible. That leaves them with little choice but to cut back on expenditures. Both BHP and Rio Tinto [ASX:RIO] have already cut back on capital projects over the next few years.
Supplementary mining companies, like Orica [ASX:ORI], expect to reduce costs by $50 million this year. In the first half of the 2014–15 financial year, Orica laid off 550 employees.
Another blue chip company cutting costs is Qantas [ASX:QAN]. By 2017, the biggest Aussie airline hopes to save up to $2 billion in costs.
And just yesterday Woolworths [ASX:WOW] announced they’ll be slashing up to 700 jobs.
What we’re seeing is a broad trend among Australia’s corporate sector to reduce costs. In order to offset falling revenues, cutting back on expenses may become the primary driver of profit growth. Add in the uncertainty facing the Aussie economy over the next 12-18 months, and you can see why streamlining programs will become more common.
Yet it’s not just Australia’s poor economic outlook affecting revenues. The effects of digitisation are proving equally problematic for many companies.
Digitisation is a threat to old business models, and will remain a persistent problem for companies
Cost-cutting measures are in part a response to the effects of digitisation. That’s because technological innovation has severely affected older business models. Take the airline industry for example.
Airlines are still coming to terms with the effects of digitisation in areas ranging from in-flight retailing to check-in efficiency. These present both opportunities and threats for the entire industry. For one, airlines can grow revenues by improving the efficiency of these systems. At the same time, the process of digitisation comes with its own collateral damage. Often, that means that people lose their jobs. But, equally important, failing to improve digital efficiency can lead to a loss of market share. That too could send airlines towards more cost-cutting programs.
According to Deutsche Bank, companies will need a ‘consistent response that can’t be confined to one particular efficiency program’. Those that can achieve that will find it easiest to manage the pressures of falling revenues in a depressed economy.
Nonetheless, the question of digitisation will remain critical over the next few years for most Aussie companies. With boards and executives facing pressure from investors to maintain growth, cost-cutting will remain on top of the agenda. Some investors may hold concerns for growth that’s derived from cost-cutting. But that’s not likely to matter too much in the end.
The crucial point is that many companies are still prioritising dividends and share prices as a selling point to investors. As long as that remains the trend, then investors won’t care too much about how companies grow their profits — as long as they do it.
Contributor, The Daily Reckoning
PS: The Aussie economy’s struggles are beginning to catch up with the share market. The ASX200 has already lost $29 billion of its value since February alone. Experts see falling stock valuations as a sign that a much larger collapse is imminent.
The Daily Reckoning’s Vern Gowdie believes we’re going to see a catastrophic crash in stocks. Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of the Australia’s Top 50 financial planners. And he thinks the ASX could lose as much as 90% of its $1.8 trillion value.
That’s why Vern’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report, Vern wants to help you avoid the coming wealth destruction. He’ll show you which five blue chip Aussie companies could destroy your wealth. And you almost certainly own one of them. To find out how to download the report, click here.