In Brief: Surging Costs; Household Stress; Housing Decline; Wet Concrete

Weekly Reports | Apr 14 2022

Surging business costs threaten margins; pressure on household budgets; rising rates to lead to falling house prices; the Big Wet hitting construction earnings

-Surging wholesale and labour costs set to squeeze business margins
-Rising cost of living and higher rates to hit consumer spending
-Falling house prices to weigh on property developers
-Persistent rain from Sydney to Brisbane impacts on building material demand

By Greg Peel

The Cost to Price Lag

This week’s National Bank business confidence survey showed a jump in the confidence index of 3 points to +16, amidst a rise in the business conditions index of 9 points to +18. The reason conditions are currently so buoyant despite the surging costs of doing business is because retail prices are being sufficiently raised to maintain earnings margins.

But not for long, Jarden warns.

Selling price increases are actually lagging well behind record cost increases for wholesale goods and labour, suggesting potential margin pressure ahead. One reason for the lag is the covid-driven shift from “just in time” inventory management – in which costs are kept at bay by holding only enough inventory to pass through quickly to consumers – to “just in case” – in which businesses have been stockpiling in order to get ahead of supply shortages and keep their customers happy.

Businesses can increase prices on inventory purchased earlier at a lower cost and thus stay ahead, until it all catches up. Eventually higher retail prices will impact demand, to the point additional inventory is at risk of collecting dust. To keep prices below the level of demand destruction, earnings margins will need to sacrificed.

This underscores the importance of “pricing power”, Jarden notes. Consumer staples businesses enjoy greater pricing power as we still need to buy food come what may, and of course that goes for the likes of wine as well. This is not true for consumer discretionary businesses.

To that end, Jarden’s retail sector preferences are for the supermarkets, Woolworths ((WOW)), Coles ((COL)) and Metcash ((MTS)), vegetable grower Costa Group ((CGC)) and Treasury Wine Estates ((TWE)).

Inflation and Household Spending

Which leads us to the other side of the equation – the consumer.

Inflation has surged for food and fuel prices, rent and utilities. And the market is now pricing in the most aggressive rate-hike cycle since 1994. Rising costs will particularly impact on lower and middle income households, Jarden notes.

Higher income households represent around 60% of consumption, but Jarden does not see this group increasing its spending in the face of inflation to offset belt-tightening for lower income households.

The full story is for FNArena subscribers only. To read the full story plus enjoy a free two-week trial to our service SIGN UP HERE

If you already had your free trial, why not join as a paying subscriber? CLICK HERE