Profit margins will be more art than science this earnings season. Let’s see if investors like Picasso.
In industries from consumer goods to manufacturing, virtually every line on the income statement is experiencing a degree of stress. In recent months, raw materials, labour and freight have become significantly more expensive and hard to come by. Struggling to keep up with demand, businesses are getting creative — in how they fill orders, how much they charge for their products and where they cut back on spending. “The pandemic ate my profits” may have worked a year ago. “My profits are trapped on a cargo ship in the Pacific” is a tougher sell.
Companies set to kick off the third-quarter earnings season in the coming weeks include S&P 500 heavyweights Johnson & Johnson and Netflix Inc, as well as Domino’s Pizza Inc and Fastenal Co. Here’s what shareholders need to know:
Supply chains are still backed up. Chief executives were optimistic heading into summer that bottlenecks and soaring freight rates would ease. Instead, they became much worse, putting logistics operations — normally the quiet workhorse of corporate America — front and centre for earnings calls.
Some companies are already revealing their hacks. Honeywell International Inc has rerouted ships to less-clogged ports, while also redesigning certain products to adapt to the semiconductor shortage. Unable to secure enough of the standard 20-foot shipping containers, Coca-Cola Co is importing ingredients on vessels normally used to haul bulk commodities such as coal. And Home Depot Inc and Walmart Inc have decided to charter their own boats.
Even so, paint giants PPG Industries Inc and Sherwin-Williams Co, electrical-equipment maker Eaton Corp and lock maker Allegion Plc have warned that they will have less revenue this quarter because of difficulty securing parts and
materials. There’s at least a potential glimmer of hope: Drewry data show the rate for a 40-foot container traveling from Shanghai to Los Angeles dropped last week by almost $1,000, or 8.2%, the steepest weekly decline since March 2020.
Is demand the new worry? Throughout the supply-chain meltdown, strong customer demand has been a consolation. The big question is, what happens if that starts to give way? While slower growth might alleviate some freight stress, it could also spark a massive selloff. In late September, retail stocks dropped sharply after Bed Bath & Beyond Inc suggested spending on home furnishings was easing. Watch for any signs of a broader pullback in demand.
Economists at Goldman Sachs Group Inc lowered their forecasts for US growth this year and next because a more delayed recovery in consumer spending is now expected, due to Covid-19 and continued remote work.
How high can you go? Consumer-products makers, fast-food chains and manufacturers have aggressively — and successfully — raised prices to mitigate any drag on profits. But with some companies now on their nth round of increases, customers may start to fight back against the inflation trend. Indeed, Wolfe Research’s latest survey of industrial distributors suggests some customers are starting to rethink their willingness to pay any price to get products.