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Ailing economy saps corporate profits

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The deteriorating economic recovery is showing up in bottom lines across Corporate Canada.

Operating profits at both private and publicly-traded companies in the second quarter fell 4.9 percent from the previous quarter and rose just 1.5 percent from last year, the slowest annual pace since the recession, according to a Statistics Canada report released Tuesday.

Sluggish economic growth in the U.S. and recession in Europe put a drag on exports, while inventory buildups depressed oil prices and low interest rates weighed on insurers. Manufacturers, oil and gas producers, and insurance firms posted a drop in operating profits, which came to a total of $71.9 billion in the second quarter, Statscan said. The fall in profits followed two consecutive quarterly increases, including a 7.1-percent gain in operating profits at the end of 2011.

In a speech to the Canadian Auto Workers last week, Bank of Canada Governor Mark Carney called for businesses to speed up investment of billions of dollars of cash, which he called “dead money,” sitting unused on corporate balance sheets across the country.

“To a certain extent this report provides a little bit of an explanation as to why they’re sitting on so much cash,” said Leslie Preston, an economist at Toronto-Dominion Bank. “I think it’s understandable that corporations would want to hold back a bit more cash than Governor Carney I guess ideally would like them to.”

But parting with a “cushion” of cash might be a tall order for many companies that have watched as the economic recovery struggles to find a foothold since the beginning of the year.

“There’s just not the same level of confidence in the overall economy that we saw going in this year,” said Mel Svendsen, president of the privately held Standen’s Ltd., a Calgary-based manufacturer.

Orders at his company are about 10 percent lower than sales forecasts in some customer segments, Svendsen said.

Customers in the transportation industry that buy Standen’s trailer axles and other vehicle components are waiting until replacements are absolutely necessary before making a purchase, he said.

“People are curtailing investment in anything related to transportation because typically transportation is related to trade.”

More than 50 percent of Standen’s sales go to customers in the U.S., where the economy grew just 1.5 percent annualized in the second quarter. The resulting uncertainty and weak demand for exports from Canada’s largest trading partner have a big effect on Canadian business. Recession in parts of Europe add to the problem.

“Europe sales are off,” said James Kierstead, co-owner of Thorsby, Alta.-based Blue Falls Manufacturing Ltd., the maker of Arctic Spa outdoor hot tubs. As a result, profit at his company is down about 6 per cent since the beginning of the year, Kierstead said.

About 20 percent of his company’s sales are in the European market, Kiersead said, but he’s trying to build more market share in Canada and the U.S. where he said he sees more signs of stability.

Beyond manufacturing, companies in the financial sector and oil and gas industry led the 19 per cent drop in second-quarter earnings reported by companies trading on the Toronto Stock Exchange.

Slower credit growth in Canada will continue to temper the pace of earnings growth in the financial sector into the future, said Robert Kavcic, an economist, BMO Nesbitt Burns.

While temporary refinery shutdowns are to blame for part of the earnings weakness in oil and gas companies, volatile oil prices for Canadian producers will be an issue for as long as pipeline capacity to the U.S. is limited, pushing Canadian prices down as inventories build up. Second-quarter profits for oil and gas producers were down 34 per cent on an annual basis.

A pickup in corporate earnings depends on U.S. economic growth, said TD’s Preston said. She predicts profits to continue to grow at a modest pace, in line with overall Canadian economic growth, until late 2013.

“As U.S. growth [picks up] as the housing sector improves, and consumer spending gets stronger, that’s going to help lift exports for Canadian businesses,” she said.

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