THE 8 BENEFICIARIES OF FURTHER COST CUTTING

Recent analysis from S&P found that the trend in cost cutting (a trend that is most evident in our expectation ratio) is likely to continue to be the primary driver of earnings in the coming few quarters.

• Although revenue from the past 12 months fell 12.7% from September 2008, quarterly sequential revenue rose 1.7% for the second consecutive period at the end of the calendar third quarter. It remains below levels from last year, but the sequential growth is nevertheless an improvement compared with trends from March 2008 to March 2009.

• After increasing CGS for almost four years since 2005, the S&P 100 companies eliminated more than $400 billion from their CGS during the 12 months since September 2008. Compared to last September, 12 month CGS fell 12.9%, which represents 9.3% of the aggregate 12 month revenue at September 30.

• On a quarterly basis, actual CGS is higher than its low in March 2009, but it remains well below last year’s levels. The 6.7% rise in CGS during the past two quarters may imply that CGS could have bottomed and that companies are responding to the increased quarterly sales.

• As a percentage of sales, 12-month CGS fell through 2009 as spending fell because of reduced demand. However, the decrease in the CGS ratio (CGS/sales) did not fall as much as we initially expected. In reality, it remains above the mean of the past decade, and it is significantly higher than levels from 2005 to 2007. On a quarterly basis, the CGS ratio is rising again.

• SG&A expenses, from a quarterly or rolling 12-month basis, have not fallen since last year like CGS, but the increases seen during the past five years have been halted.

• However, SG&A expenses as a percentage of sales declined slightly during the past quarter after spiking during the quarters following September 2008, likely as a result of lower sales and flat SG&A costs. However, on a 12-month basis, SG&A costs as a percentage of sales continue to rise significantly higher than historical levels.

But how do you play this continuing trend in cost cuts?  In recent conference call coverage Goldman Sachs highlighted 8 firms that are likely to benefit most from this continued trend in cost cutting:

Abbott Labs (ABT) forecasted continued SG&A cuts:

“It’s a steady target for us to leverage SG&A. We did ramp it quite a bit prior
to ’09… But focusing more on non-value-added area and the more administrative type costs, IT, those types of things, we’re very, very focused on – there’s no reason for a lot of those costs to grow. They should be flat to down…”

Pfizer (PFE) is on track to meet cost cutting goals and sees further expense reductions:

“We reduced our adjusted total costs by 5% compared to the year-ago quarter… We remain on track to achieve our $2 billion net cost reduction target… by 2011… We continue to have several opportunities for outsourcing which include manufacturing, logistics, finance, facilities, legal, and IT…”

Alcoa (AA) has plans for further headcount reductions and expects 75% to be permanent:

“We began to take action last year to quickly redesign operations and… reduce
head count. For the last five quarters, we’ve identified reductions of 22,200… over 19,000 of which have been completed… Although it’s not an exact science, we estimate that 75% of the positions are permanent reductions.”

General Electric (GE) slashed costs 10% and has another $700 million under scrutiny:

“We continue to reduce base cost throughout the year… our third quarter base
costs were down 10%… We’ve got a funnel of about $2 billion plus on ideas, all
with a two-year payback… We’ve got another $700 million being reviewed for
potential fourth-quarter and 2010 execution.”

Grainger (GWW) expects one-third of cost cuts to be permanent:

“Ongoing cost reduction efforts led to a 7% decline in operating expenses year over-year… We expect about one-third of the decline in operating expenses in 2009 to be permanent while the remainder may return with improved volume and the return of bonuses and other performance-related costs.”

EMC Corp. (EMC) cut expenses faster than anticipated yet sees further reductions in 2010:

“We are investing in transition efforts to reduce our long-term cost structure and we’ve spent $35 million so far in 2009. … we continue to be well ahead of our plan for cost savings of $450 million in 2009 versus 2008. We also continue to target $500 million in savings in 2010 versus 2008 from these initiatives.”

Microsoft (MSFT) cut costs at a rapid pace over the past year and expects further cuts:

“During the quarter we also continued to focus on our long term cost structure. We realized a 10% decrease in operating expenses over the prior year … We will
continue to look for additional cost savings opportunities, both in cost of goods
sold and in operating expenses through the rest of the fiscal year.”

Dow Chemical (DOW) were ahead of schedule on cost cuts and expect more to come:

“We remain ahead of our goal here as well. And regarding workforce reductions
…these decisions are obviously very difficult, they are a key part of our total cost savings effort and we have already achieved 77% of our stated goal.”

Source: GS, S&P