Consumer Industries Doing Better

The latest word from Economy.com on consumer service and retail industries is that things are looking up.

Consumer industries as a whole have performed better than other industry groups since the recession and several industries that languished during the past two years seem to be getting their bearings. As a group, revenue growth is expected to reach 6.4% this year, slightly below the 6.9% growth reached in 2002, though still the best performing group of industries.

Perhaps more importantly for the economy going forward, profits are sturdier this year. This is vitally important. While much of the improvement is attributed to cost cutting, particularly for retailers, hotels and gaming, and the manufactured housing industry, improved pricing power also plays an important part for such industries as restaurants and medical equipment. The biotechnology, internet and cable industries, which have enjoyed double digit revenue growth for years but no profits, are finally turning a profit.

Profit margins for consumer industries exceeded 5%, the best performance in four years. Stronger profitability will allow for further expansion and improve the prospects for a return to hiring during the balance of this year. Revenue growth is expected to exceed 7% in 2004 as global economies gain further momentum.

What about health care, which is a large employer in most regions? While still strong, growth is moderating in the health-related industries though profit margins continue to improve. For-profit hospitals are reporting across-the-board gains, thanks to successful consolidations and cost-cutting plans implemented over the past few years. The health insurance industry remains in top form. Three years of accelerating double-digit premium hikes and aggressive reorganization and cost cutting have enabled most insurers to boost profits and stock prices significantly. Not-for-profit hospitals remain on shakier ground with narrow profit margins, but performance has improved over the past year and is trending upward. Higher private and government reimbursements are supporting these improvements. Utilization and prices are still growing at a steady clip and an estimated $25 billion of hospital projects are currently under construction. The greatest downside risk to healthcare providers is burgeoning state deficits, which will certainly lead states to cut back on the Medicaid services they offer.

As growth moderates for heretofore stellar industries, other consumer industries, including restaurants and recreational goods and services, are enjoying above-average revenue growth through mid-year as a result of cyclical improvement, which will accelerate through next year. This explains why so many new restaurants are coming on stream in many metro areas. People still want to go our and eat. Stronger pricing power is a key ingredient to better industry performance for such industries as restaurants. Prices of food purchased away from home, a good proxy for menu prices, are up 4.5% over the past two years, comfortably ahead of the rise in wholesale prices for food during that period. Revenue growth is twice as high mid-2003 as a year ago.

Growth in sales at discount merchandisers, as well as specialty retailers, has also accelerated in recent months thanks to strong household cash flow due to tax cuts, rebate checks and cash-out refinancing. As we reported earlier this week, Wal-Mart is eating many grocers' lunch.

Economy.com estimates that households extracted more cash from their real estate in the first half of this year, more than they did all of last year. Not all consumer industries are enjoying strong or strengthening conditions. A turnaround in revenues for the hotels and gaming, entertainment, printing and publishing and newspaper industries will mirror macro trends.

Despite the recent gains for consumer spending and growing evidence of a firm rebound in the macro economy, consumer industries that depend on discretionary consumer spending still face near-term risks. Weak labor market conditions threaten household incomes and confidence. Wage growth is also slowing, as employers limit pay raises and consumers remain heavily indebted. Moreover, there is little pent-up demand for consumer goods. The disposable income curve is one to watch in your area to gauge where consumer services and retail will head in the next 6-12 months.

Certain consumer industries face structural obstacles. Both traditional department stores and certain specialty retailers, such as furniture stores, are constrained by competition from discount department stores. As a result, pricing power is weak and profitability is well below the industry average. Indeed, deflation remains the norm for specialty retailers.

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