One of the best ways to monitor the health of an economic expansion is to watch companies' profit margins. And the latest news on profit margins in Canada shows stress symptoms.
Total corporate profits are up 7.5 per cent compared to a year ago, which is good news. The economy-wide profit margin is quite strong, at 8.1 per cent in the second quarter of 2006. This is well above the five-year average margin of 7.4 per cent, and marks a pretty steady improvement from the six- to seven-per-cent range back in 2003. The recent peak profit margin was during the last three months of 2005, at 8.3 per cent.
A majority of the economy's sectors are profiting from the steady growth Canada has been experiencing. On balance, 15 out of 18 sectors have profit margins that are above their average for the last five years.
Profitability is being led by the mining sector in particular, where the profit margin recently hit 18.9 per cent, well above the five-year average of 14.2 per cent. Profit margins are running at 19.6 per cent in oil and gas extraction, more than 18 per cent in real estate and 22.9 per cent in finance and insurance.
One profit laggard is the utilities sector, where margins have fallen to 5.3 per cent from averages in the seven- to eight-per-cent range back in 2004 as high fuel prices take their toll.
Another laggard is the accommodation and food service business, which always has low margins in the first place. The sector has seen its margin fall from a five-year average of 3.3 per cent to 2.4 per cent, a 25-per-cent cut, as the strong Canadian dollar is biting into American tourist visits and reducing hotel and restaurant receipts.
And then there is the manufacturing sector, which is also lagging the rest of the economy in profitability. Caught between a strong Canadian dollar and high resource costs, the sector has seen its overall profit margin decline from just over six per cent in late 2005 to 5.5 per cent most recently. The problem is fairly widespread - the majority of manufacturing sub-sectors have profit margins below their five-year average levels.
One really soft spot is the motor vehicle sector, with a profit margin of only 1.1 per cent, about half the average over the past five years. The industry is investing in its future efficiency, but it will have to endure a period of slow U.S. sales in the next 12-18 months.
The clothing and textile sector has seen its profit margin fall to 1.1 per cent, a huge percentage cut from the five-year average of 2.8 per cent.
Other sectors that are being squeezed include non-metallic minerals, with a margin of 5.3 per cent compared to an average of 8.1 per cent; wood and paper (4.2 per cent versus 5.3 per cent); furniture (3.1 per cent versus 4.3 per cent); transportation equipment (3.5 per cent versus 4.6 per cent); and printing (3.7 per cent versus 4.9 per cent).
It is harder to find expanding profit margins in the manufacturing sector.
One is the primary metal sub-sector, where margins are now about nine per cent versus a recent average of 7.8 per cent. Others include computers and electronics (6.2 per cent versus 3.2 per cent) and electrical equipment (3.7 per cent versus 3.2 per cent).
The bottom line? Despite the evident disparity in profit performance, all sectors have one thing in common: They will face slower sales growth and reduced pricing power in 2007.
Profit margins will probably contract in most sectors in the coming months.
(Stephen Poloz is a senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
