Cyclicals Get That Sinking Feeling

DuPont joins Alcoa and Phelps Dodge as 'disappointing.' Does three make a trend?
Author:
Publish date:

DuPont's

(DD) - Get Report

warning about profits Wednesday makes it the third such negative forecast in as many days from a cyclical company, aka one whose fate is directly linked to the economy.

DuPont's 3.2% slide was recently weighing on the

Dow Jones Industrial Average

. But with oil prices receding, the blue-chip index was holding onto a small gain of 0.05% and stayed above the 11,000 mark, recently trading at 11,017.The

S&P 500

was up 0.15% to 1291, and the

Nasdaq

was up 0.17% to 2324.

Besides DuPont, aluminum giant

Alcoa

(AA) - Get Report

kicked off the fourth-quarter earnings season with disappointing results on Monday, and copper-mining giant

Phelps Dodge

(PD) - Get Report

slashed its profit forecast by 70%.

Of course, three companies, even giant ones, don't necessarily make a trend. But their individual stories do tell a story that's worth heeding. It's a story about rising input costs and slowing consumption.

On the one hand, a bullish market for commodities should benefit a mining company such as Phelps Dodge. Chinese and global demand has pushed copper prices to 16-year highs. But boosting production requires more costly exploration, and those operational difficulties seem to have hit the copper giant.

Higher up the production stream, purchasers of raw materials, such as DuPont, are facing higher prices, mostly energy, while being unable to pass it down. "It's a double whammy," says Morningstar analyst Sumit Desai.

Both Alcoa and DuPont conveniently cited Hurricane Katrina's impact on production as partly contributing to their disappointing results. But it's worthwhile to note that both derive a good chunk of their revenue from the auto industry: 18% for Alcoa and 23% for DuPont, according to stock analysts at Morningstar. That's not helpful.

"Auto sales have collapsed at an annualized rate of 38% in the fourth quarter," says Asha Bangalore, economist at Northern Trust. Mainly because of this slump, consumer spending will barely be positive in the quarter and overall GDP economic growth is expected to have slowed to roughly 3% in the fourth quarter compared to 4.1% in the third, she says.

With the big three automakers

GM

(GM) - Get Report

,

Ford

(F) - Get Report

and

DaimlerChrysler

(DCX)

furiously cutting costs, its suppliers down the chain are obviously having a hard time passing on higher input costs.

Beyond Alcoa, which provides aluminum, and DuPont, which provides coating to the auto industry, steel producers such as

U.S. Steel

(X) - Get Report

and

AK Steel

(AKS) - Get Report

are hit even harder, says Morningstar analyst Scott Burns.

In terms of broader economic trends, there could be worse than slumping auto sales. It wouldn't be surprising to learn that consumption already was hit by the cooling housing market in the fourth quarter, according to Bangalore, who says that trend is sure to accelerate in 2006.

Such a scenario doesn't bode well for the likes of DuPont, which derived 12% to 13% of its revenue from sales of construction materials in 2004, according to Morningstar.

Still, the commodity boom that has been fueled mostly by Asian growth, and the ability of different players to handle higher costs, has made it harder to determine what defines broad economic impact trends. The likes of equipment-makers

Caterpillar

(CAT) - Get Report

and

John Deere

(DE) - Get Report

, for instance, have had an easier time passing on higher costs.

Economic slowdown or resilience? Inflation or no inflation? Ben Bernanke, the soon to be new chairman of the

Federal Reserve

, will need to sift through it all before we can expect the central bank to cease hiking rates.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

click here

to send him an email.