Investor's Guide:
|  - Ted's columns via RSS feed
| Either Prices Are Going Up Or Margins Are Going Down
|  
|
February 8, 2011 - You may not have felt it yet, but inflation is running rampant for certain commodities. Prices for some raw materials like cotton, oil, aluminum, tin and many others have skyrocketed in the last year. Manufacturers from electronics to apparel are feeling the pain as they report lower earnings due to higher raw materials costs. That can only mean one thing: prices will be going up on many items in the near future or profit margins will be lower, driving down earnings.
If the first scenario plays out, then inflation will start making a comeback as it will take more dollars to buy the same products. That means a semiconductor chip that cost $2.50 last year may cost $2.75 this year. Same chip, just more expensive. Or an all cotton shirt that cost $50 this year will go to $60. Same shirt, just more expensive. Here are some examples of the rise in raw materials costs over the last year: cotton went from 84 cents a pound in July of 2010 to $1.68 a pound in December 2010. That's up 100%. Crude oil went from $74.49 a barrel in July of 2010 to $90.10 in December, up 21%. Corn went from $163.92 per metric ton in July of 2010 to $251.02 in December of 2010, up 53% in six months. Aluminum was at $1989.05 a metric ton in July of 2010 and finished the year at $2356.69 a metric ton, up 18.5%. Most other commodities or raw materials followed the same pattern. The most obvious place most of us see this kind of movement is at the gas pump. Those prices are fairly sensitive to changes in the cost of oil. It takes a while longer for others to work their way into products. Still, when things cost more for the manufacturer, the price has to go up or, if it doesn't, profit margins are squeezed. A good example is ArcelorMittal, the largest steel maker in the world. It recently released earnings, a loss of $780 million for the last quarter of 2010 compared to a profit of $1.1 billion in the last period of 2009. The problem: higher raw materials costs, paticularly for iron ore and coking coal, two most important elements for making steel, and sinking prices for steel. But management's forecast was very upbeat: it sees demand for steel on the rise and steel prices also, in sync with raw materials costs. In fact, sales increased in the final quarter by 4.8% to $20.7 billion as shipments increased by 3% to 21.1 million tons.
Every manufacturer wants to pass on the cost of making their products. But many can't because of global competition. Take the car industry. There are models for every niche, from sports cars to mini-vans to SUVs. Each car maker has strong competition no matter which niche it offers. And, ultimately, for most buyers, the winner is the one with the lowest price. So if a manufacturer in Korea can make a car or SUV at a lower price but with the same quality as one made in the U.S., it's going to take market share (see Hyundai for the most recent example). The cost of raw materials is most likely lower in Korea due to lower labor costs. So the U.S. manufacturer has a dilemma: either raise its price to cover its higher materials and labor costs (and lose market share) or keep the price competitive with foreign imports and make less money. It's the same story in every industry. That's why now is a good time to review a stock portfolio and see which companies are heavily dependent on raw materials for their products. Cars are one of them. Electronics equipment are another. Apparel makers another. All will have a tougher time making profits as the cost of raw materials increases. Most likely they will as India and China see their economies continue to enjoy strong growth. As economies grow, they demand more goods and services, putting upward pressure on all prices from food to energy. Raw materials can catch up from more planting and more drilling, but it takes a while. Over the next year, expect to see inflation rising. And if the stocks you own don't raise prices on their products, it can only mean one thing: their profit margins will shrink. And investors don't like that. - Ted Allrich |
Weekly Newsletter
printer-friendly format