Most Large Companies Should Have Some Ability to Pass on Rising Costs

Most corporate bond issuers have some ability to pass rising costs on to customers via pricing and, to a lesser extent, reducing costs with greater operating efficiency, says Fitch Ratings in a new report.

The service is predicting inflationary pressures are likely to linger into 2022 and potentially threaten US corporate margins from the sharp uptick in demand after reopening from the coronavirus lockdowns and supply-chain challenges.

For inflation, Fitch has revised its expectation to 4.4% for all of 2021 from its forecast in September and 2.7% for 2022 from the estimate it gave in June.

Fitch said the increase in part is due to supply-chain constraints, housing costs and a greater share of demand growth being reflected in price increases.

But the firm noted the ability of businesses to cope with rising inflation by mitigating the effect of upward prices, wages, energy and transportation costs depends in part on the elasticity of demand and competitive intensity. “The ability of some high exposure sectors to mitigate the effects on margins should be good. Autos, homebuilders, utilities and gaming have a strong track record of protecting margin and benefit from a consolidated industry structure and/or inelastic demand,” the report predicted.

Fitch’s 2021 Investor Advisory Council of institutional investors said their focus is on pricing power of businesses and the effect of inflation on high-yield corporate bond issuers, which may be more at risk due to less financial flexibility.

Inflation, said Fitch, will probably be longer lasting through increases in labor costs.

Businesses also may have long-term problems getting enough employees as workers weigh the benefits of working against pandemic-related health concerns and the pandemic pushes baby boomers into early retirement, the report pointed out.

Rising wages and raw material costs, two of the heaviest burdens in inflation, are anticipated by Fitch to hit homebuilders and restaurants.

The report said declining affordability could affect ongoing pricing power for homebuilders while restaurants have a high ability to pass along costs due, in part, to high personal savings rates during the lockdown, pent-up demand and rising food-at-home prices.

Relatively inelastic demand for some of what they sell has given building products companies a high ability to pass on costs in less discretionary segments such as coatings, commodities, plumbing, fixtures and other low-cost items, according to Fitch.

Builders of commercial projects have seen the increased efforts to meet demand bring “above-average increases in construction costs,” according to a recent construction outlook report from JLL.

“Through August, average final construction costs for a commercial project had increased 4.5%, and total cost growth by year end is likely to surpass 6%,” the report reads. “A similar level of cost escalation, in the range of 4 to 7%, is expected into 2022,” though the materials component of the estimate is “the lowest confidence forecast due to the wide range of inputs and global supply chains bucketed into a single category.”