U.S. inventory rebuild could plump up earnings

NEW YORK (Reuters) - U.S. corporations look ready to go on a spree to replenish their inventories, if the reading on second-quarter GDP is anything to go by -- with manufacturers and shippers likely to benefit from the move.

During the recession, companies have cut back aggressively on new production and reduced inventories. But analysts expect corporate America to start restocking those inventories, especially before the holidays.

The inventory buildup could position companies to meet a potential revival in demand and this would help beef up their earnings.

"When the economy does better because let's say, manufacturing companies no longer can sustain declining inventories, so they hire or rehire and increase production to at least maintain inventories, that itself generates more income and greater capacity for consumers to spend money," said Charles Lieberman, chief investment officer of Advisors Capital Management, LLC in Paramus, New Jersey.

The second-quarter earnings season has been stronger than expected as companies embarked on drastic cost cutting, which has boosted their bottom lines.

Over 70 percent of the Standard & Poor's 500 companies that have reported earnings so far have beaten analysts' estimates.

The U.S. government's report last Friday, which was its first look at second-quarter gross domestic product, showed that GDP declined less than analysts had expected. In contrast, inventories dropped a record $141.1 billion in the quarter, which dragged on overall GDP.

GDP GROWTH SEEN BACK IN STYLE

Many analysts are calling for a return to growth in the third quarter. On Wednesday, Goldman Sachs raised its real GDP forecast for the year's second half to 3 percent from 1 percent, annualized. Goldman also said the latest GDP data shows more second-quarter inventory liquidation than it had expected, which it said could mean a bigger boost to production as companies try to match demand.

"October is traditionally the big month for (inventory) build, and I think that's the month people are really going to be looking at," said David Wyss, chief economist at Standard & Poor's in New York. "That's the start of the new auto model year. By October, you're getting 2010s into stock, and October is when retailers have to start getting the inventory in for Christmas sales."

Initially at least, rebuilding inventories would help those companies that are in manufacturing and transportation, as well as in raw materials, said Howard Silverblatt, earnings analyst at Standard & Poor's, which is part of the McGraw-Hill Companies.(MHP.N)

Diversified manufacturers include such companies as 3M Co (MMM.N), a Dow component whose products range from Post-It notes to electronics and health care supplies, and Honeywell International Inc (HON.N), which makes products as varied as aircraft components and engines, automotive supplies, chemicals and specialty materials for a host of industries.

Among the world's biggest shipping or package delivery companies are FedEx Corp (FDX.N) and United Parcel Service Inc (UPS.N), whose stocks are among those in the S&P 500 Index.

Raw materials companies that could benefit from a rebuilding of inventories include steelmaker Nucor Corp (NUE.N), whose chief executive said on Wednesday that steel demand was beginning to pick up again after eight months and should get a boost from the U.S. government's "Cash for Clunkers" auto rebate program.

"The mix is very favorable for GDP growth, beginning in the third quarter," Lieberman said.

But a lot hinges on consumer demand.

Consumer spending, which accounts for two-thirds of U.S. economic activity, dropped in the second quarter, after rising in the first quarter, the latest GDP report showed.

It's tough to say whether companies will be rebuilding sharply or just stop destocking, S&P's Wyss said. Businesses don't want to lose out on sales, but they also don't want to get stuck with big inventories.

WANTED: HEALTHIER REVENUES

Revenues have not been as rosy as bottom-line earnings numbers in the latest batch of quarterly reports, and analysts have said a sales pickup is crucial to better corporate results going forward.

"If you don't have the consumer to get that top-line revenue growth, eventually there's only so much you can get," said Alan Lancz, president, Alan B. Lancz & Associates Inc, an investment advisory firm, based in Toledo, Ohio.

As it stands, second-quarter earnings for S&P 500 companies are estimated to have fallen about 29 percent from a year ago, while third-quarter earnings are expected to decline 21.5 percent. according to data compiled by Thomson Reuters.

Second-quarter estimates have improved from a forecast just weeks ago that called for an earnings drop of 36 percent from the year-ago period.

Seventy-four percent of the S&P 500 companies that have reported earnings so far have beaten analysts' expectations.

And that's given the U.S. stock market the fuel to sustain its sharp spring rally, which had sputtered in June, to get a second wind in July and end the month with sharp gains. The Dow Jones industrial average .DJI shot up 8.6 percent in July -- its best percentage gain for July since 1989.

After Wednesday's close, network equipment maker and tech bellwether Cisco Systems (CSCO.O) reported a fall in quarterly revenue, while life insurer Prudential Financial (PRU.N) lowered its full-year outlook and auto insurer Allstate (ALL.N) reported an operating profit that was short of expectations.

Next week, a slew of retailers are set to post results.

About 375 S&P 500 companies have reported results so far this period. Thomson Reuters data showed that if the final percentage of companies beating estimates stands at 74 percent, it will mark the highest percentage of companies surpassing expectations for a quarter since it began tracking the data in 1994.

The next reading on second-quarter real GDP is expected on August 27. Analysts will tweak estimates from now until then.

"When you look at inventory numbers, we are setting the stage for a better environment," Lancz said. "But the question is, 'How much has the market already reflected that?'"

(Reporting by Caroline Valetkevitch; Editing by Jan Paschal)