Can Profits Weather the Slowdown?

(Stephen Poloz, Export Development Canada)

The profitability of Canadian companies remained strong overall at least until the end of 2007, despite concerns about the economic storm clouds gathering just south of the border. Is the situation unique, and therefore sustainable, or an accident waiting to happen?

Total Canadian corporate profits were up 9.2% in the four quarters ending in 2007Q4. This pace was far in excess of the economy’s growth rate, which means that profits continued to rise as a share of total income. The leading profit-growth sectors were arts and recreation (63%), construction (26%), retail trade (25%) and real estate (19%). In contrast, profits were falling in sectors like agriculture, forestry, fishing and hunting (-32% overall), mining (-6%), oil and gas (-1%) and repair, maintenance and personal services (-6%). Manufacturing profits were up 3.3%.

Some of these results seem surprising, such as the strength in retail trade and weakness in mining and oil and gas, not to mention positive profit growth in manufacturing. But these data can be volatile, even when measured on a year-ago basis. It is helpful to look at profit margins, which are much smoother. The profit margin for the economy as a whole was 8.9% in 2007Q4, a very solid number. This number was as low as 3.3% back in late 1992, in the aftermath of recession, but spent most of the 1990s in the 6-7% range. In 2000 it drifted above 7%, faltered to 5.3% in late 2001, but then recovered steadily. In 2005, the aggregate profit margin moved above 8%, and it has fluctuated in a narrow range between 8.5% and 9.0% since that time.

One might suspect the oil and gas sector was behind this trend, but not so. Profitability in that sector peaked in 2005, and has been declining since. Even so, its five-year average profit margin is about 19%, more than double the economy average. In fact, the uptrend in overall profitability is mainly due to mining, where the margin has more than doubled since 2001-02 to around 18%, and finance and insurance, where margins have risen from 15-16% to about 27% in the same period. Real estate has moved up a little, too, to almost 20% most recently.

As for manufacturing, its overall profit margin at the end of 2007 was 6.3%, still in a range that has been typical for much of the past decade, except during the 2001-02 slowdown. Sub-sectors of rising profitability include non-metallic mineral products (15.8% most recently), computers and electronics (10.7%), and alcoholic beverages and tobacco products (25.0%).

Many other manufacturing sub-sectors are being squeezed, including motor vehicles (-1.2%, although parts manufacturers are still doing better overall, at 7.3%), wood and paper (1.1%), clothing and textiles (1.2%), furniture (3.6%) and primary metals (5.7%). But there is also a group that is showing relatively stable profitability, so far: transportation equipment; fabricated metal and machinery; chemicals, plastics and rubber; petroleum and coal products; food and soft drinks.

The bottom line? So far, the profit damage from the U.S. slowdown has been limited to a few sectors. This puts extra weight behind the recent survey of investment intentions by Statistics Canada, which indicated that investment will be a positive for the Canadian economy in 2008.