Has Inflation Arrived?

General Mills, the maker of the famous ‘Cheerios’ cereal brand, fell as much as 10 percent this week following a downgrade related to margin pressure from cost inflation. CEO Jeff Harmening blamed a 20-year high in freight costs for the margin squeeze, sending the price of other packaged food brands lower over the day.


Across the other side of the globe, reports of a price hike of toilet paper in Taiwan sent nervous consumers to completely clear local convenience stores of their dwindling supplies. There are plenty of these kind of stories circulating the media, which begs the question: are these examples merely localised phenomena, or is there a more systemic driver at hand? We lean towards the latter.


Though not universally felt, cost pressure was a consistent sore point for the Australian companies that reported over February. This generally fell into three categories; wages, energy costs, and raw material costs. Whilst it’s still early days, it appears cost inflation has arrived, and is an area that we will be watching keenly over the coming months.


Here is a little snapshot of some of the cost pressures we saw emerging this February:


  • ABC.ASX: Delivered an FY17 result towards the bottom end of guidance previously given to the market, with an underlying EBIT margin decline of circa 110bps. Cost headwinds were flagged by the company as the driver of the margin erosion with rising coal and electricity costs hitting the Lime & Cements businesses.


  • ANN.ASX: Nitrile & natural rubber prices continued to rise through 1H18, driving input costs higher for the business. Cost inflation was a US$17m headwind in the 1H, equating to around a 230bps of EBIT margin compression in the Lime & Cements businesses.


  • BXB.ASX: Saw extensive cost inflation across their US & European business units over 1H18. Transport costs were up 5% across the US and 4% across Europe in addition to Lumber costs rising 7% Europe. Company statement:

                  – “Market Cost inflation increases in 1H18, with further acceleration in December & January” 


  • HSO.ASX: Operating margins for Healthscope’s hospital business unit took a hit as rising wages in 1H18 drove a substantial increase in operating costs. Company statement:

                -“A decline in Hospital Operating EBITDA of 8.6% reflected adverse patient case mix. One-off planned brownfield disruptions and a range of costs, including wages, which increased   faster than health fund price indexation, also impacted the result.”


  • WOW.ASX: In their 1H18 result the company flagged a 29bp increase in their food business costs related to rising wages, electricity costs and rent. CEO Brad Banducci stated:

                -“…we have the natural cost pressures that everyone else has on the EBA and on electricity and rent.”


  • WES.ASX: Much like Woolworths, Wesfarmers flagged wage inflation in their Coles outlook statement:

              -“…divisional earnings in 2H18 expected to be affected by increased team member costs…”


  • ORA.ASX: Rising electricity costs in Australia were the focus of Orora’s management for the Australian business. They guided to an increase in operating expenses of $6-8m directly related to rising electricity prices – a 40bp erosion of their EBITDA margin. Company statement:

            -“Australian electricity market is expected to continue to be volatile for the foreseeable future and presents further potential downside risk”


  • BHP.ASX: Despite rising volumes, all major business units experienced increasing costs of production per unit. The rise across the board in the company’s per unit costs of production was attributed to increased energy costs and wages, in particular at their Escondia mine. Further to this, the company raised the cost per tonne for QLD coal by 11.2%, flagging ‘production from higher cost pits and rising inflationary pressures’.


  • BSL.ASX: Cost headwinds were flagged by the company across both North America and their Australian business units. BlueScope’s Australian Steel products faced ‘headwinds from higher energy costs’ that are expected to escalate through 2H18 as coking coal and electricity prices continue to rise. North American operations were impacted by rising prices of raw materials ‘upward pressure on electrode, refractory and alloy costs’ that are expected to add a further $5m to costs in 2H18.


  • AWC.ASX: The AWAC JV saw a 4% rise in their cash cost of production per tonne. This came despite a substantial rise in production volumes as global demand for Alumina and Bauxite rose.


  • S32.ASX: Saw $2.8bn of market capitalisation wiped off South 32 in seven trading days as a substantial rise in the firms cost base surprised the market. Cost pressures for Raw materials and inflation linked royalties drove cost per production above guidance and saw the firm lift their FY18 costs of production. Company statement:

            -“The group’s cost base was primarily impacted by external inflationary pressures”


  • SCP.ASX: Highlighted the drastic rise in electricity prices stating that ‘the full year cost of electricity across our portfolio is expected to increase by around 30%’.  The likely impact on their FY18 results will be a negative 40bp hit to their margins. When the landlord is only taking on a third of these costs it flags to us that retail tenants are in for a hit to the bottom line.


  • NINE DRAGONS PAPER: For one on the supply side, Nine Dragons Paper have pushed through three price hikes for their paper products. Whilst positive for the firm, this should rear its head as cost inflation further down the supply chain.




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