Profit Forecasts Feel Europe's Effect

By JAMES R. HAGERTY And DANA MATTIOLI

Europe is a mess. China is disappointing. So investors will be watching nervously as U.S. companies report quarterly earnings over the next few weeks for any signs of collateral damage in the American economy.

Friday's report that U.S. consumer spending was flat in May was the latest sign that ordinary shoppers, like many chief executives, are cautious. Macroeconomic Advisers said the economic consulting firm's panel of forecasters trimmed its projection for U.S. economic growth this year to 2.1% from the 2.4% expected two months ago. Gross domestic product rose 1.6% last year.

"Macroeconomic visibility is as poor as I've ever seen," said John Stroup, chief executive of Belden Inc., which makes electrical cables. Though the U.S. market has remained strong for Belden, the company is reluctant to add much to its head count or capacity. "We don't want to get too far ahead of ourselves," Mr. Stroup said.

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Earnings forecasts already have come down sharply for companies that rely heavily on Europe, such as General Motors and Ford. Above, GM's Vauxhall unit plant in Ellesmere Port, U.K.

Despite the recession in much of Europe and slower growth in China, Wall Street has trimmed earnings forecasts only modestly. The consensus forecast for composite operating earnings for companies in the Standard & Poor's 500-stock index is $104.55 a share for this year, according to FactSet, down just 0.8% from the forecast three months ago.

Projections for companies with heavy exposure in Europe, such as some auto makers, have dropped sharply, however.

Ed Yardeni, an economic forecaster in Brookville, N.Y., said forecasts probably will fall further after companies report second-quarter results and revise their outlooks. He expects earnings of $102 a share for the S&P 500 this year. If he's correct, earnings growth would be just 5%, after jumps of 14% last year and 39% in 2010, when the economy was emerging from a deep recession.

"If there are any disappointments [in earnings reports], I'm sure most of them will be out of Europe," Mr. Yardeni said.

Scott Davis, a Barclays Capital analyst who follows industrial companies, said risks have been rising, including the dangers of "Europe falling further into recession and China not recovering" soon. Such developments would likely further weaken the U.S. economy, he said.

China's economic growth slowed to an annual rate of 6.6% in the second quarter from 6.8% in the first, J.P. Morgan estimated. The firm forecast growth of about 8% in the second half, still sluggish by China's standards. Mr. Davis said he feared China won't really pick up steam before next year.

Aside from weaker demand in Europe, U.S. companies are being hurt by the fall of the euro, which reduces the dollar value of earnings made there. Forecasts already have come down sharply for companies that rely heavily on Europe, such as General Motors Co. and Ford Motor Co.

Overall, estimates for second quarter S&P earnings are 3% lower than they were three months ago, FactSet said. But the estimates for GM and Ford have been cut by more than 25%. As of Friday, analysts were projecting that GM's second-quarter earnings would be about 45% below the year-earlier level. Ford warned Thursday that it expected to report "substantially lower" pretax operating profit for the quarter, largely because of heavier losses outside North America. Morgan Stanley projected a decline of about 65% in Ford's second-quarter earnings per share.

So far, 74 S&P 500 companies have lowered their second-quarter forecasts, while 28 have raised them.

Lower energy and commodity costs are helping many companies reduce costs. But that is offset by European weakness and a stronger dollar, "so it could be a wash," Mr. Yardeni said. Given disappointing economic performances in Europe, China and India, "profits have held up remarkably well," largely because of resilience in the U.S. economy, he said.

So far, orders remain "quite strong," said Jim Dicke III, president of Crown Equipment Corp., a family-owned maker of forklifts. The New Bremen, Ohio, company has annual sales of about $2.1 billion. But "I'm not sure that's a sustainable situation," Mr. Dicke said. Uncertainty over the European financial crisis and the U.S. elections, among other things, could deter spending on equipment, he said.

David Haffner, chief executive of Leggett & Platt Inc., which makes parts for furniture, autos and other products, said the company will stay profitable in coming quarters.

"We've seen significantly softer demand in Europe than we have in North America," Mr. Haffner said. About 10% of the company's annual sales of around $3.6 billion come from Europe. Leggett's European clients began to scale back orders last quarter, he said. In response, Leggett has closed some of its factories in Europe.

But business in North America has improved over the past year and remains strong, Mr. Haffner said, as Americans have resumed buying big-ticket items like cars and furniture.

"People have put off new purchases long enough and they are replenishing them," he said.

As earnings are reported, Barclays's Mr. Davis will watch anxiously for any sign that investment in mining or oil-and-gas production is falling off because of lower metal or energy prices.

Global sales growth for Caterpillar Inc.'s machinery used in construction, mining, energy and other areas has been trending downward. In the three months through May, sales were up 11% from a year earlier. That compared with growth of 27% in the three months through January. Even so, Caterpillar has projected record earnings this year, and analysts generally haven't made big changes in their second-quarter estimates.

At Reata Engineering & Machine Works in Englewood, Colo., a small maker of parts for medical equipment and aircraft, first-half sales were up about 28% from a year earlier, said CEO Grady Cope. He expressed concern about Europe but added, "I can't believe Greece could cause the world to fall into another Great Recession."

A version of this article appeared July 2, 2012, on page B1 in the U.S. edition of The Wall Street Journal, with the headline: Profit Forecasts Feel Europe's Effect.