Cautious Price Hikes Help Drive Robust Earnings
Companies in a range of industries appear to be doing something they haven’t done in quite a while: They’re raising prices.
That’s one reason why first-quarter corporate earnings reports have been so robust, providing support for a troubled stock market.
The price hikes in sectors as varied as chemicals, medical care and beer seem very modest overall, experts say.
And to be sure, for many companies, strong earnings are more a function of hefty sales growth and/or continued cost-cutting and productivity gains than rampant price increases.
Still, economists and Wall Street analysts say anecdotal evidence suggests that some companies increasingly are getting away with price increases for their products or services without alienating customers--a significant turn of events from the recent past.
Many companies refrained from boosting prices in the last several years for fear of losing customers to lower-priced rivals. Those that did raise prices often had to roll them back.
But an April survey by the National Assn. for Business Economics showed the percentage of firms raising prices in the first quarter to be the highest in four years.
More telling, a whopping 94% of price hikes have stuck.
“The message here is that the era of price declines and the era of [downward] pricing pressure has ended,” said Richard Berner, chief U.S. economist at Morgan Stanley Dean Witter in New York.
Blistering profit growth would seem to back up that idea. First-quarter corporate earnings are likely to rise about 24% over the year-earlier quarter, according to Thomson Financial/First Call.
That would be the best since the 25.2% registered in the fourth quarter of 1993.
There’s little doubt that the same powerful forces that have driven profit growth throughout the 1990s--including improving productivity and a surging U.S. economy--are primarily responsible for the first-quarter results. A pickup in growth in Europe and Asia also is helping.
But because profits “are a lot stronger” than even last year’s boiling-hot performance, “something different is going on out there that is lighting up earnings,” said First Call’s research director, Chuck Hill.
Though few companies specifically point to price hikes as a bottom-line factor--it’s not politically correct to say so, after all--Hill suspects that increased pricing power is having an impact on earnings.
“It’s more anecdotal than a real movement starting, but we weren’t seeing anecdotal [signs] before,” he said. “We’re on the verge of seeing pricing power emerge in a meaningful way.”
Though it may seem counter intuitive, pricing power is a mixed blessing for investors.
On one hand, many investors may want to own shares of companies that can raise prices because those firms would seem to have an edge in improving revenue and earnings.
On the downside, however, some companies appear to be raising prices because they’re faced with rising labor costs and have no other way to maintain profit margins.
Indeed, the government’s report last week on first-quarter wage and benefit costs showed the biggest gain in a decade.
“The price increases are very measured and very cautious,” said Gary Schlossberg, senior economist at Wells Capital Management. “The environment remains very competitive, and I don’t know that businesses are jumping for joy because many of the increases are simply meant to counter cost pressures.”
Other companies have faced higher raw-materials costs, particularly for energy, as oil prices have surged over the last year.
Shippers such as Federal Express have increased prices in part because of oil prices, said Paul Kasriel, chief economist at Northern Trust Co.
But manufacturers on the whole have simply swallowed the added shipping costs, he said. “You’ve not really seen the pass-through into the finished-goods prices,” he said.
Of course, if corporate pricing power were to become widespread, it could be disastrous for the economy--signaling resurging inflation across the board.
Federal Reserve policy makers, who have already raised short-term interest rates five times since June, could be compelled to raise rates sharply to slow the economy if they believed that upward pressure on prices was broad-based.
But is that what’s occurring? Economists disagree.
At Merrill Lynch & Co., an in-house indicator based on various economic statistics shows inflation picking up at its fastest pace in two decades, said Rich Bernstein, head of quantitative analysis.
But other economists believe inflation overall will remain subdued. Many note, for example, that crude oil prices have slumped from first-quarter peaks as major exporting nations have boosted production.
In a survey reported Monday, manufacturers nationwide said they continue to pay more for many raw materials, though the increases moderated from March levels.
For investors looking to zoom in on companies that may have increased pricing power--and thus may show healthy earnings momentum in the quarters ahead--it’s important to realize that a company may enjoy strong pricing for any one of several reasons.
And spotting pricing power may not be enough. The bigger question is whether it’s sustainable. Companies boosting prices one month may have to reduce them the next based on momentary economic and supply forces, experts say.
Here’s a look at some of the factors helping to give certain industries and companies pricing power in the first quarter:
* Stronger demand and tighter supplies for commodities. These factors have certainly helped energy companies: Energy-sector profits were up 215% in the first quarter from a year ago, Thomson Financial/First Call says.
Likewise, profits at basic materials firms rose 63% on average.
Within basic materials industries, paper and chemical prices still appear to be strong, some experts say. But prices for aluminum and other metals have recently weakened. “It’s a stop-and-start type of environment,” said Hugh Johnson, chief investment officer at First Albany Corp.
In many cases, investors haven’t bid up stocks with supposed pricing power, he said, because they’re not sure how long it will last. Weyerhaeuser shares, for example, are down 29% from their 52-week high despite strength in paper and wood prices.
Similarly, despite big earnings gains at energy firms such as Amerada Hess and Occidental Petroleum, many analysts expect profits to be lower next year.
But many analysts remain bullish on energy companies heavily involved with natural gas.
U.S. gas stockpiles are down 25% from a year ago, despite a warm winter.
* Strong demand for value-added technology. Many semiconductor companies reported stellar first-quarter earnings amid booming demand worldwide. Wall Street expects the appetite for chips to remain robust this year.
Not only are sales soaring for many chip firms, but so are profit margins. That suggests that the companies have significant relative pricing power, even in an industry where prices are perennially falling.
At chip company Altera, for example, gross margins were at an all-time high in the first quarter, according to Prudential Securities.
Other chip firms whose earnings momentum appears very strong include Intel, PMC-Sierra and Applied Micro Circuits.
* Price increases in long-depressed industries. Most companies haven’t boasted about price increases, but there are exceptions.
Anheuser-Busch said last week that its first-quarter profit gain was due in part to two recent beer price hikes--in October and February--that have been “accepted by the market.”
Likewise, Columbia/HCA Healthcare, the nation’s largest hospital chain, crowed about price hikes when it unveiled a 13% quarterly profit increase last week.
“We have every expectation we are going to continue to see strong rate increases,” Jack Bovender Jr., Columbia president, told analysts.
Many health-maintenance organizations likewise have raised rates, and gotten employers to accept them--a factor in the first-quarter jump in benefits costs.
Finally, in the airline industry, fare hikes have helped offset higher oil prices, providing much more optimism about earnings growth into 2001.
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Profit Surge
First-quarter operating earnings for the blue-chip Standard & Poor’s 500 companies are expected to be up about 24% from a year ago, which would be the strongest gain since 1993. Year-over-year earnings growth by quarter:
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First quarter 2000: 24%*
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*Estimate
Sources: Standard & Poor’s, Thomson Financial/First Call
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Stocks With Earnings Momentum: A Sampling
Many companies reported stronger-than-expected first-quarter earnings, and for different reasons. Below is a list of companies that brokerage PaineWebber views as “earnings momentum” stocks in the near term, based in part on the companies’ first-quarter results. At technology companies such as Andrew Corp. and Applied Micro Circuits, profit growth is largely a function of robust sales growth. At energy firms such as Amerada Hess and Enron, higher prices for oil and gas have boosted results, though Wall Street is less optimistic about 2001 earnings. At airlines such as Delta and consumer-product firms such as Anheuser-Busch, price increases have helped to bolster results.
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Ticker 1st qtr. Change from Est. EPS: Company symbol EPS year ago ’00 ’01 Aflac AFL $0.58 +21% $2.37 $2.73 Amerada Hess AHC 2.47 +437 5.49 4.76 Andrew Corp. ANDW 0.21 +133 0.82 1.15 Anheuser-Busch BUD 0.76 +15 3.28 3.63 Applied Micro Circuits AMCC 0.16 +60 0.77 1.06 Delta Air Lines DAL 1.33 +2 7.02 7.55 EBay EBAY 0.05 +25 0.36 0.67 Enron ENE 0.40 +18 1.40 1.63 Golden West Financial GDW 0.78 +11 3.13 3.61 Illinois Tool Works ITW 0.72 +16 3.38 3.80 Intel INTC 0.71 +25 3.01 3.50 Murphy Oil MUR 1.05 NM 3.49 3.46 Occidental Petroleum OXY 0.72 NM 2.06 1.90 Pfizer PFE 0.28 +33 1.06 1.26 PMC-Sierra PMCS 0.17 +183 0.78 1.11 PMI Group PMI 1.33 +39 5.46 6.20 Sapient SAPE 0.19 +171 0.78 1.10 Southwest Airlines LUV 0.18 0 1.01 1.19 Tenet Healthcare THC 0.48 +20 1.78 2.00 Weyerhaeuser WY 1.04 +104 4.53 6.24
Stock price, ’00 Company Mon. close P/E Aflac $48.31 20 Amerada Hess 64.19 12 Andrew Corp. 29.25 36 Anheuser-Busch 70.00 21 Applied Micro Circuits 126.00 164 Delta Air Lines 54.63 8 EBay 155.63 432 Enron 72.31 52 Golden West Financial 35.00 11 Illinois Tool Works 63.75 19 Intel 127.13 42 Murphy Oil 59.25 17 Occidental Petroleum 21.88 11 Pfizer 41.81 39 PMC-Sierra 188.00 241 PMI Group 49.94 9 Sapient 84.25 108 Southwest Airlines 21.88 22 Tenet Healthcare 24.31 14 Weyerhaeuser 52.63 12
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NM=not meaningful (compares to loss in year-ago period)
EPS=earnings per share
P/E=price-to-earnings ratio
Sources: PaineWebber; Reuters; Zacks Investment Research; Bloomberg News
