Higher Costs Starting to Appear
September 22, 2004
Unedited
Residential real estate has been one of the driving forces behind the economy. This week, the Commerce Department reported that housing starts slightly increased in August rising to 2 million starts on an annualized basis. This was better than economists forecasted and matched the pace set in March, which was the fastest rate this year. Building permits, however, fell to 1.95 million. Not only was this over 100,000 permits lower than last month, but about 30,000 lower than analysts forecasted.
Strong housing data along with stellar third quarter results induced investors to bid up KB Home’s stock price to a new all-time high. Revenue increased 21% to $1.75 billion and earnings per share rose 22%. Net new orders jumped 23%, pushing backlog up 42% to $4.82 billion. The company expects the good time to roll and told investors that it now expects earnings to be $11.00 per share next year.
Lennar announced that revenue increased 21% with earnings per share jumped 12% to $1.36, which was about two pennies higher than analysts expected. Investors were less impressed with Lennar’s results due to a large portion of earnings that came from land sales. Most of the disappointment came from the large portion of earnings that came from land sales. Wall Street analysts were not expecting land sales to contribute seventeen cents to earnings, without the higher than expected land sales the company would have actually missed analysts’ forecasts.
Several consumer related companies either announced lower than expected earnings or pre-announced over the past week. Coca-Cola started the parade last week. The leading soft drink company announced that volume growth has been weaker than expected in the US and in Europe. During the conference call, Coke blamed part of the weak volume growth on grocers were taking more margin on Coke products. Merrill Lynch noted in a research report the day following Coke’s confessional that carbonated soft drink volumes fell 5.1% in August, while pricing increased 3.6%. The drop in volume accelerated from last month’s 4.6% decline and is well below the year-to-date drop of 3.6%. Pricing also accelerated in August.
ConAgra reported that net income fell 31% for the quarter ending August 29, although sales increased 8%. The company cited, “significantly increased input costs across the industry” as the reason for the drop in income. The company expects to raise prices over the next 90 days to offset the higher input prices. If Coke is experiencing lower volumes due to higher prices, the ability for other companies to raise prices will be challenging.
Earning at General Mills for the quarter that ended August 29 fell 19% from last year’s level. Part of the decline was due to restructuring charges, but even excluding the charges, EPS fell to $0.55 from $0.59. These estimates were already guided lower once. In June, the company told analyst that earnings for the full year were going to be lower than last year. The decline was due to higher costs; most notable was the $70 million in extra expense due to higher commodity costs. While the company announced that it was raising prices to offset higher commodity prices, the company had to honor discounts to grocery stores that were in effect before the announced price hikes. We wonder if the company was actually able to get the price increases to stick.
Colgate said that increased marketing spending and higher raw material costs will cause earnings to be more than 10% below analysts’ forecasts. Additionally, the company forecasts that higher raw material costs will remain high, but will not continue to accelerate higher. The personal products company also said that it plans to increase advertising spending in order to gain market share.
The recent consolidation in the grocery business combined with Wal-Mart becoming a dominate player in the category, has changed the landscape that food companies operate in. Not only do the food companies have to contend with larger customers that can better negotiate better pricing, but most grocery stores are aggressively marketing their private label products. This lead to grocery stores to push for lower prices from food companies, but not lower prices to consumers as they maximize the “value” of their own labels. This is a difficult strategy in the ultra-competitive grocery business, especially with Wal-Mart flexing its muscle.
The “Wal-Mart effect” even transcends the retail space. Most transportation companies have reported very good results recently and indicated that future results would be much better than last year. This week, FedEx reported that earnings per share increased over 150% on a 23% jump in revenue. It did, however, guide forward earning lower than what analysts were expecting. One notable exception was Swift Transportation. Last week, the leading truckload carrier announced it would miss analysts’ estimates due to increased fuel costs and an inability to raise prices. Considering that several other transportation companies have announced price increases including, Yellow Roadway, Fedex, UPS, Swift appears to be an anomaly. You guessed it, Wal-Mart is Swift’s largest customer.
Worthington Industries announced that fiscal first quarter earnings soared almost 900% on a 54% gain in revenues. The metal processing company said that its processed Steel Products segment experienced 14% higher volumes and prices were up 39% from last year. Additionally, it said that “economic and industry conditions have improved across all customer segments except ‘Big 3’ automotive.” The company noted that commercial construction has rebounded off multi-year lows. This seems to be a reoccurring theme among the steel companies along with the construction companies. On the topic of lackluster auto sales, GM and Ford announced that it will offer zero-percent six-year loans to help clear out 2004 model year inventory.
We have discussed rising commodity prices for several months. Investors seemed quite content to watch commodity prices escalate as long as there was no apparent increase in consumer prices. Neglecting the problems with the CPI and other measures of inflation, if commodity prices were increasing, but prices for final products were not, clearly companies had to absorb higher prices. Investors are starting to learn that this means lower profit margins and lower earnings. This also complicates how investors usually manage their portfolio. Cracks have started to form in several market groups that normally act as leadership, namely technology and financials. Consumer staple stocks are usually viewed as defensive positions as are rotated into when investors get nervous regarding “higher beta” positions. Now, however, these normally defensive positions are coming under pressure. |
