Innovation

Profit squeeze getting worse

Written by Stephen Poloz

There is a widespread perception that the Canadian profit picture is a strong one. True, aggregate corporate profits are up significantly, but that hides a lot of stress beneath the surface.

Overall Canadian corporate profits are growing at a 15% rate, according to the latest figures, which is a very healthy number. But the experience is far from universal: profits are up strongly in the energy sector (67%) and in mining (48%); much less so in construction (5%) and finance (4%); and in the manufacturing sector as a whole profits have declined by 5%.

Profit margins are being squeezed in many manufacturing sub-sectors. While the overall manufacturing profit margin is running at about 6%, about equal to the average over the past 15 years, it is down from 6.5-7.0% a year ago. How tough the situation depends on what business you are in: margins are in reasonable shape relative to history in food and beverages, alcohol and tobacco, printing, energy, chemicals and plastics, fabricated metals, machinery, computers and motor vehicle parts. In contrast, margins are being squeezed in paper, non-metallic minerals, primary metals, electrical equipment, motor vehicles, transportation equipment and furniture.

One reason for margin compression is that the prices of some key manufacturing inputs have risen significantly, including energy, metals and plastics. A second is that the Canadian dollar has appreciated by about 6 cents during the past year, which translates export prices expressed in U.S. dollars into lower Canadian dollar revenues. And third, a wide range of Canadian companies have no ability to raise their prices — in fact, some are being forced to cut them.

Consider the recent statistics on consumer prices in Canada, which rose by 2.2% during the past year. Energy costs led the way — natural gas rose by 11.9%, while heating oil rose by 16.2%. Related to this, transportation services rose in price by 4.3%. Autos rose by 3.1%. Shelter costs by 2.8%. Services in general rose by 2.1%, which is about the same as overall inflation.

But there are a number of other sectors in which prices are rising by less than the overall rate of inflation — indeed, deflation is evident in some of them, including household furnishings (-0.4%), clothing (-0.9%), appliances (-2.2%), travel (-3.3%), home entertainment (-3.4%), sporting goods (-3.8%) and computers (-18.1%). These are the sectors most exposed to international competition, where the ability to raise prices to improve profit margins is the most limited. These are also the sectors where the impact of the strong Canadian dollar is likely to be greatest. Similarly, the only sector outside of manufacturing that has seen a significant profit margin compression is the accommodation and food services sector — essentially hotels and restaurants — which is also very sensitive to the exchange rate.

The bottom line? The Canadian economy is in good shape, and in broad terms it is likely to remain so through 2006. But beneath the surface are important stresses brought on by the current global situation, including high energy costs and a strong currency. Adjustments to those stresses are likely to dominate our macroeconomic picture at least for the next 12 months.

February 2, 2006

Originally appeared on PROFITguide.com