Rising prices
wages and profitability. With what the world's largest companies came to the end of the year
In the US, the reporting season is coming to an end. Analysts and executives had many concerns about the slowdown in corporate earnings growth, primarily due to rising costs associated with inflation. But so far the gloomiest predictions have not come true. What conclusions can an investor draw for the future?
In the US, the reporting season is coming to an end. Analysts and executives had many concerns about the slowdown in corporate earnings growth, primarily due to rising costs associated with inflation. But so far the gloomiest predictions have not come true. What conclusions can an investor draw for the future?
Of the 92% of companies in the S&P 500 that reported by November 5, 81% exceeded analysts' expectations for earnings per share (EPS), according to data from Factset. This figure is less than in the first two quarters of 2021, when the economy was actively recovering, but even with this result, the ended quarter could enter the top 5 since the start of calculations in 2008. On average, companies surpassed the forecasted EPS by 10.1%, and most often the players in their healthcare, IT and real estate sectors pleasantly surprised analysts.
The mixed EPS growth of companies from the S&P 500 index (it takes into account both already reported companies and those that have yet to do so) amounted to 39.1% yoy. For comparison: at the end of the quarter, analysts were expecting an increase of 27.4%. Companies from the finance and healthcare sectors were the most contributors to the beating of forecasts.
Also, 75% of companies reported higher-than-forecasted revenues - the average excess was 2.8%. If this figure persists through the end of the reporting season, it will share the third place (since 2008) with the fourth quarter of 2020. Blended revenue growth is 17.5%, the second highest in history, up from 14.9% analysts had forecast on September 30.
The successful reporting season is partly due to the low expectations of analysts before the start of the season: they feared a slowdown in economic recovery due to the delta strain of coronavirus and rising costs for companies due to disruptions in supply chains, higher energy prices, raw materials and labor costs.
The rise in labor costs requires a separate explanation: the coronavirus has led to early retirement of more than 3 million Americans, Marketwatch wrote, citing a study by the Fed. This may be due to the higher vulnerability of older people to the virus and to rising stock and real estate prices. These people can still return to the labor market, but so far the shortage of personnel leads to an increase in companies' expenses.
Restaurants - big employers, mostly for the least qualified employees - have indeed raised prices due to rising wages and food prices. For example, McDonald’s on October 27 announced a 6% increase in prices in the United States over 2020 due to a 10-15% rise in wages and a 3.5-4% rise in goods costs. Starbucks announced an increase in the minimum wage in American outlets from $ 14 to $ 17 per hour: the salary of employees will increase by 5-10%.
Consumer companies also had to take this step. Coca-Cola raised prices back in April, that is, before it went mainstream, and Kraft Heinz raised the price of ⅔ of products sold in the US in September. The head of the company hinted at a possible increase in prices if costs continue to grow further. Procter & Gamble announced additional price increases for some of its products in October. This is explained, in particular, by the fact that the corporation's transportation costs in 2021 may amount to $ 2.1 billion instead of the $ 1.9 billion expected back in June.
So far, there is a feeling that companies are successfully shifting the growth of their costs to consumers, according to analysts polled by The Economist. The same Coca-Cola, McDonald’s and Kraft Heinz reported better than expected. The head of McDonald’s noted that consumers were "quite good" about the increase in prices, and the head of Coca-Cola said the same. Procter & Gamble beat analysts' forecasts in both revenue and profit.
In addition, companies are not sitting still, but looking for ways to reduce costs, writes Bloomberg. For example, Chipotle has introduced an online ordering service. As a result, although the company's mixed profitability in terms of net income fell from a record 13.1% in the second quarter of 2021 to 12.9%, it could still become the second highest since the beginning of calculations.
Only nine of the 11 sectors have improved their profitability indicators compared to the third quarter of 2020, and all 11 have reported better than the average for 5 years.
The largest banks - JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Morgan Stanley - were better than analysts' expectations, despite concerns about rising technology and labor costs. In the third quarter, consumers were actively spending money: during the pandemic, they reduced their consumption and received incentive payments. This supported the results of commercial banks, while M&A transactions remained the main driver of the investment banking business. As a result, banks are now literally drowning in cash: since the beginning of the pandemic, they have attracted deposits of trillions of dollars, but at the same time the level of lending has fallen - many have used the savings to pay off loans. For example, Wells Fargo and Bank of America had a smaller loan portfolio for the quarter than a year earlier. In addition, banks are one of the few to benefit from rising inflation and changing expectations for an earlier rate hike. As rates rise, their interest income increases, since the cost of funding for them grows more slowly than the cost of the loans they issue.
In the tech sector, the impact of supply chain disruption has been felt by Apple and Amazon selling physical goods, WSJ notes. Apple's 81% of its revenue comes from devices, which are mainly shipped from China, while Amazon's 75% of its revenue comes from the sale of goods, so they are also at risk of rising personnel costs. At the same time, their forecasts for the IV quarter turned out to be worse than expected, and the shares fell 4% after the release of reports. Microsoft, Google and Facebook, which have the majority of their revenues from digital business, on the contrary, performed well. Alphabet and Microsoft both hit all-time highs after record highs. The situation with Facebook, which announced its renaming to Meta, is more complicated: the company has almost all of its revenue from digital advertising, so it has been hit hard by the introduction of Apple's new privacy rules. According to FT estimates, in the second half of the year, the company will lose $ 8.3 billion - 13.2% of revenue because of this. Snap will lose the same share of revenue, which has dropped by a quarter after the release of the report and has not yet recovered - another reminder of how vulnerable fast-growing companies are.
What an investor should think about
Inflation is not slowing down yet, which means that companies may have to raise prices further. Mentioning of increased labor and supply chain costs has increased in calls to analysts by about four times compared to the same period last year, Bloomberg writes, citing data from Bank of America (BofA). The mention of the word “price” - a proxy for pricing power, that is, the ability to shift increased costs onto the consumer - increased by 45%. According to Factset,
BofA believes this indicates that there will be no further growth in profit margins in 2022. If so, investors need to pay more attention to companies that have pricing power (get used to it: you will hear this phrase more and more often).
But everything indicates that the "hunt" for companies with pricing power started in early October, Bloomberg points out. For example, since early October, Goldman's portfolio of high and stable profit margins, including Nike, Procter & Gamble, Johnson & Johnson, Oracle, 3M, Adobe and others, outpaced low and volatile profit margins by 7 pp - 10 % versus 3%.
the difference between the price of the product and the marginal cost;
large and stable net profit margin;
the size.
All other things being equal, companies with a larger market share have more pricing power. A recent survey of US CFOs by Duke University and the Federal Reserve Banks of Richmond and Atlanta found that 85% of large US companies plan to pass costs on to consumers, compared with 72% for small ones.
In October, UBS compiled a list of 10 companies with sufficient pricing power and at least 20% growth potential. It includes, for example, Apple (a large proportion of customers are satisfied with the product, which means they will not switch to other brands), Nike (because of the strength of its brand), Salesforce.com (the company increases operating profitability), etc.
At the same time, BofA analysts are more pessimistic than their colleagues, who cover individual companies. The consensus forecast based on the analysis "bottom-up" - growth in profit margins in the next two years, writes Bloomberg. The last season of reports showed that so far analysts have bet too early on reducing margins.
The mixed EPS growth of companies from the S&P 500 index (it takes into account both already reported companies and those that have yet to do so) amounted to 39.1% yoy. For comparison: at the end of the quarter, analysts were expecting an increase of 27.4%. Companies from the finance and healthcare sectors were the most contributors to the beating of forecasts.
Also, 75% of companies reported higher-than-forecasted revenues - the average excess was 2.8%. If this figure persists through the end of the reporting season, it will share the third place (since 2008) with the fourth quarter of 2020. Blended revenue growth is 17.5%, the second highest in history, up from 14.9% analysts had forecast on September 30.
At first sight
The successful reporting season is partly due to the low expectations of analysts before the start of the season: they feared a slowdown in economic recovery due to the delta strain of coronavirus and rising costs for companies due to disruptions in supply chains, higher energy prices, raw materials and labor costs.
The rise in labor costs requires a separate explanation: the coronavirus has led to early retirement of more than 3 million Americans, Marketwatch wrote, citing a study by the Fed. This may be due to the higher vulnerability of older people to the virus and to rising stock and real estate prices. These people can still return to the labor market, but so far the shortage of personnel leads to an increase in companies' expenses.
If you understand
Restaurants - big employers, mostly for the least qualified employees - have indeed raised prices due to rising wages and food prices. For example, McDonald’s on October 27 announced a 6% increase in prices in the United States over 2020 due to a 10-15% rise in wages and a 3.5-4% rise in goods costs. Starbucks announced an increase in the minimum wage in American outlets from $ 14 to $ 17 per hour: the salary of employees will increase by 5-10%.
Consumer companies also had to take this step. Coca-Cola raised prices back in April, that is, before it went mainstream, and Kraft Heinz raised the price of ⅔ of products sold in the US in September. The head of the company hinted at a possible increase in prices if costs continue to grow further. Procter & Gamble announced additional price increases for some of its products in October. This is explained, in particular, by the fact that the corporation's transportation costs in 2021 may amount to $ 2.1 billion instead of the $ 1.9 billion expected back in June.
So far, there is a feeling that companies are successfully shifting the growth of their costs to consumers, according to analysts polled by The Economist. The same Coca-Cola, McDonald’s and Kraft Heinz reported better than expected. The head of McDonald’s noted that consumers were "quite good" about the increase in prices, and the head of Coca-Cola said the same. Procter & Gamble beat analysts' forecasts in both revenue and profit.
In addition, companies are not sitting still, but looking for ways to reduce costs, writes Bloomberg. For example, Chipotle has introduced an online ordering service. As a result, although the company's mixed profitability in terms of net income fell from a record 13.1% in the second quarter of 2021 to 12.9%, it could still become the second highest since the beginning of calculations.
Only nine of the 11 sectors have improved their profitability indicators compared to the third quarter of 2020, and all 11 have reported better than the average for 5 years.
There are areas that have been minimally affected by supply chain disruptions and staff shortages.
The largest banks - JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Morgan Stanley - were better than analysts' expectations, despite concerns about rising technology and labor costs. In the third quarter, consumers were actively spending money: during the pandemic, they reduced their consumption and received incentive payments. This supported the results of commercial banks, while M&A transactions remained the main driver of the investment banking business. As a result, banks are now literally drowning in cash: since the beginning of the pandemic, they have attracted deposits of trillions of dollars, but at the same time the level of lending has fallen - many have used the savings to pay off loans. For example, Wells Fargo and Bank of America had a smaller loan portfolio for the quarter than a year earlier. In addition, banks are one of the few to benefit from rising inflation and changing expectations for an earlier rate hike. As rates rise, their interest income increases, since the cost of funding for them grows more slowly than the cost of the loans they issue.
In the tech sector, the impact of supply chain disruption has been felt by Apple and Amazon selling physical goods, WSJ notes. Apple's 81% of its revenue comes from devices, which are mainly shipped from China, while Amazon's 75% of its revenue comes from the sale of goods, so they are also at risk of rising personnel costs. At the same time, their forecasts for the IV quarter turned out to be worse than expected, and the shares fell 4% after the release of reports. Microsoft, Google and Facebook, which have the majority of their revenues from digital business, on the contrary, performed well. Alphabet and Microsoft both hit all-time highs after record highs. The situation with Facebook, which announced its renaming to Meta, is more complicated: the company has almost all of its revenue from digital advertising, so it has been hit hard by the introduction of Apple's new privacy rules. According to FT estimates, in the second half of the year, the company will lose $ 8.3 billion - 13.2% of revenue because of this. Snap will lose the same share of revenue, which has dropped by a quarter after the release of the report and has not yet recovered - another reminder of how vulnerable fast-growing companies are.
One of the pro-inflationary factors - the lack of supply - is visible in the reports of automakers. Chip shortages cut General Motors and Ford's net profit 40% and 23%, respectively, despite record US car prices
What an investor should think about
Inflation is not slowing down yet, which means that companies may have to raise prices further. Mentioning of increased labor and supply chain costs has increased in calls to analysts by about four times compared to the same period last year, Bloomberg writes, citing data from Bank of America (BofA). The mention of the word “price” - a proxy for pricing power, that is, the ability to shift increased costs onto the consumer - increased by 45%. According to Factset,
BofA believes this indicates that there will be no further growth in profit margins in 2022. If so, investors need to pay more attention to companies that have pricing power (get used to it: you will hear this phrase more and more often).
But everything indicates that the "hunt" for companies with pricing power started in early October, Bloomberg points out. For example, since early October, Goldman's portfolio of high and stable profit margins, including Nike, Procter & Gamble, Johnson & Johnson, Oracle, 3M, Adobe and others, outpaced low and volatile profit margins by 7 pp - 10 % versus 3%.
UBS analysts pay attention to three parameters for determining pricing power, writes The Economist:
the difference between the price of the product and the marginal cost;
large and stable net profit margin;
the size.
All other things being equal, companies with a larger market share have more pricing power. A recent survey of US CFOs by Duke University and the Federal Reserve Banks of Richmond and Atlanta found that 85% of large US companies plan to pass costs on to consumers, compared with 72% for small ones.
In October, UBS compiled a list of 10 companies with sufficient pricing power and at least 20% growth potential. It includes, for example, Apple (a large proportion of customers are satisfied with the product, which means they will not switch to other brands), Nike (because of the strength of its brand), Salesforce.com (the company increases operating profitability), etc.
At the same time, BofA analysts are more pessimistic than their colleagues, who cover individual companies. The consensus forecast based on the analysis "bottom-up" - growth in profit margins in the next two years, writes Bloomberg. The last season of reports showed that so far analysts have bet too early on reducing margins.