Rising commodity prices are putting a strain on corporate costs, which are taking many investors by surprise. Most analysts focus on sales volume to initially judge a company’s ability to meet its debt obligations. Strong levels of demand, particularly across many emerging market countries, imbued an air of complacency. However, the accelerating inflation rate around the world and the rising costs of raw materials and energy are silent killers which can quickly undermine a company’s performance. The top line may be moving higher, but the bottom line may be sinking into the red. Mexico recently witnessed several of its corporates fall victim to rising input prices. Durango was a perfect example. The Mexican paper products company’s cash flow dropped suddenly during the first quarter of this year, due to the rising cost of old corrugated containers (OCC) and energy. Consequently, Fitch downgraded Durango’s credit rating to B- from B. Unfortunately, commodity prices are rising faster than most corporates can pass the price increases along to consumers, triggering an erosion of credit metrics and the loss of investor confidence.
Most commentators worry about the increase in consumer prices (CPI), but the rise in producer prices is bringing a new round of concerns to the credit markets. In the U.K., for example, producer prices jumped 19% y/y in March, while consumer prices rose 2.4% y/y. Declining demand, rising commodity prices and higher financing costs are creating the perfect storm for many companies. That is to say, without talking about higher labor costs. The growing militancy by governments around the world is also preventing many corporations from passing cost increases along to consumers. From Russia to Argentina, price controls are the order of the day. This is putting undue pressure on treasurers and CFO’s.
Although investors in energy-intensive sectors, such as airlines and thermo-electricity generation, are always sensitive to oil price movements, manufacturing caught many people unaware. Energy was always considered to be a minor input in the manufacturing process, but with oil hovering around $130 per barrel it is no longer inconsequential. Energy is now one of the more important components of the production chain. In addition to manufacturing, sectors such as mining, agriculture and petrochemicals are being squeezed. The problem is even more acute when petroleum byproducts are inputs, such as in the petrochemical, plastics and fertilizer sectors. To make matters worse, competitive pressures are keeping many marketing departments from raising their prices too quickly, which creates new headaches for CFOs. Such conditions could lead companies to reduce investment plans and postpone maintenance projects, which manifests itself in other problems further down the line.
Fortunately, some sectors are less sensitive to changes in commodity prices. This is particularly true for financial services, banks, tourism, telecommunications and media. Interestingly, many transportation and logistics companies benefitted immensely from the increase in commodity prices. Given that these companies are essential in bringing the commodities to market, they were able to pass the cost increases through to the final consumer. In some cases, they were able to charge additional premiums. There has never been a more opportune time for the trucking, railroad, barging and logistics industries. Therefore, investors and analysts need to take costs factors more into consideration when making their credit decisions. They should also be ready to reprofile portfolios into industries and sectors that are less sensitive to the volatility that is convulsing the commodity markets.