Weak profits across industries in Canada aren’t likely to turn around until commodity prices firm up and our key trading partner south of the border stages a more robust recovery.
Overall corporate profits have fallen in five of the past six quarters, according to a study from Toronto-Dominion Bank. They are now 16 per cent below their post-recession peak in late 2011.
In two crucial sectors – manufacturing and resources – profits have declined in the past six quarters, and all other groupings fall short of what was achieved in the pre-recession period of 2002-2007. Even the relatively well performing financial sector showed year-over-year profit growth of just over ten per cent in the last six quarters, well under the 15 per cent average annual growth in the five-year pre-recession period.
“The recent decline in corporate profits … is the worst outside of a recession since the tech bubble burst,” says a report from Toronto-Dominion Bank authored by economist Leslie Preston. “Corporate Canada is in a slump.”
Canadian profits, which are closely linked to export markets, have generally been dented by the slowdown in global growth, and in particular by a weak recovery in the United States, Ms. Preston said. At the same time low commodity prices dealt a “twin hit” to the resource sector. Meanwhile, continuing Canadian dollar strength and higher labour costs relative to the United States have hurt manufacturers, she said.
The weakness in Canada’s profit picture has contributed to a relatively poor performance in equities, particularly relative to the U.S. While the Dow Jones Industrial Average has set new records in recent months, the S&P/TSX Composite is still more than 10 per cent below its 2008 peak. And in the past year and a half, the market has been generally flat.
Business investment has also suffered, the TD report says. Companies have been spending less on machinery and equipment than they did in the earlier part of the recovery, and there is no sign that investment will turn around until there is a better sense of confidence among Canadian business leaders, Ms. Preston said.
The outlook could turn around if upward momentum in oil prices stays intact, she said. “We do expect that gradually, as U.S. growth improves, a lot of the manufacturing sector [will see] growth improving.”
Peter Buchanan, an economist at Canadian Imperial Bank of Commerce, projects that in the current earnings quarter, Canadian corporate profits will come in a respectable 6.6 per cent higher than a year ago. But the variation by sector is dramatic, he said.
Energy companies, buoyed by those higher oil prices, will show an average 40 per cent profit rise, while the materials group (which includes gold and base metals companies) is expected to fall by 41 per cent. The financial sector will end up in between, with a year-over-year profit rise of around 9 per cent, CIBC projects.
Mr. Buchanan said his bank is projecting an overall improvement in 2014, with corporate profits expected to rise about 9 per cent, thanks to “an appreciable pick up in the global economy.”
Still, he said, the Canadian stock market is at least a couple of years away from reaching its pre-recession levels.
David Madani, Canada economist at Capital Economics, agrees that the key to an improved profit picture in Canada – particularly for manufacturers – is an uptick in the U.S. economy. But there will also likely be some depreciation of the Canadian dollar over the next few years, he said, and that will also help. On the flip side, Capital Economics is bearish on the housing market, and that could dent profits in the financial sector.
Still, he said, “the big wild card really is commodity prices. Where commodity prices go, corporate profits tend to follow.”