US companies' first-quarter earnings have been impressive so far, but whether hard-earned revenue or lower costs are driving profits remains to be seen.
Earnings gains throughout the second half of last year were fuelled largely by cost-cutting measures - a good temporary fix but a poor way to sustain long-term growth, experts say.
The first quarter has shown signs that some businesses are making money the old fashioned way: They're selling more product.
But fat-trimming and factors such as the weak dollar, lower effective tax rates and reduced debt servicing costs are still feeding profits. The question is whether sales are picking up enough to take up the slack as the impact of these factors is likely to weaken over the rest of the year.
"I think we are seeing instances where revenue growth is becoming a more important component...," said Tim Swanson, chief investment officer for National City Wealth Management, which oversees $26 billion in assets.
"And obviously that matters, because revenue growth is theoretically more sustainable than cost-cutting."
Wall Street analysts see first-quarter revenue rising 7.9 percent for the S&P 500 companies, up from growth of 6.9 percent in the prior quarter, according to Reuters Research, a unit of Reuters Group Plc. But growth is expected to slide throughout the rest of 2004, down to 4.6 percent by the fourth quarter, leading some analysts to question just how long solid earnings gains can hold.
"I don't think we're experiencing a sustainable recovery," said Chip Hanlon, chief operating officer for Euro Pacific Capital, which manages $300 million. Earnings are still dominated by cost-cutting measures, he said.
This week Johnson & Johnson, a diversified health-care giant, and Siebel Systems Inc, a top software vendor, both reported quarterly profits boosted by job cuts.
The weaker dollar also remains a crutch for many US companies, as overseas sales are worth more when converted into dollars.
International Business Machines Corp said on Thursday that without the weak dollar, its first-quarter revenue would have risen only 3 percent. And Johnson Controls Inc, the No. 4 US auto parts maker, also said revenue was helped by the weak dollar.
However, with the dollar recently recovering some of its losses of the past year, this is likely to be less beneficial going forward.
The same can be said for low interest rates, which hold down debt servicing costs.
Rates have been at their lowest levels in years, but in the past few weeks Treasury bond yields, the benchmark rates for much corporate and consumer borrowing, have been rising, and the Federal Reserve is now expected to raise its key rates later this year.
Lower interest expenses helped Southwest Airlines Inc reduce its interest bill by $7 million, or 27 percent, in the first quarter.
But several money managers and economists see solid revenue growth in the current round of earnings reports.
Reliance Steel & Aluminum Co a metals processor and distributor, said rising steel prices coupled with strong demand quintupled its profit, and revenue jumped 46 percent to $655.8 million.
Investment banks are also seeing strong revenue growth, with Lehman Brothers Holdings Inc. more than doubling its first-quarter profit, driven by an 84 percent rise in revenue thanks to strength from bond and equity trading.
"Profit margins are back to something normal," said Brian Nottage, director of macro-economic forecasting at Economy.com. "Now we're seeing solid top-line growth".
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