HOW CAN BUSINESSES WITHSTAND AN ECONOMIC SLOWDOWN?
Mark Lister, 7 August 2018
There are two words I think investors and analysts need to become very familiar with over the next few years. Pricing power.
As economic growth tapers off a little, it’s going more difficult for businesses to grow their revenues as much as they have been in recent years. At the same time, costs are steadily rising.
That’s a nasty combination for those who can’t pass these increases on without losing customers. A slowdown in revenues while operating expenses continue to rise means margins get squeezed and profits fall.
Listed companies in this situation could face share price pressure on two fronts. Investors will value them lower because of decreasing profitability, and also due to question marks over margin sustainability.
Global economic growth remains solid, although activity has clearly slowed from earlier in the year. Trade tensions, rising interest rates and mixed messages out of China are all contributing to a slower growth outlook.
The domestic economy has also come off the boil, and it’s not just business confidence surveys telling us so. House prices are much more subdued, consumer spending is a little softer, and the migration boom is past its peak.
Companies will have to contend with this less buoyant picture of demand, as well as steadily increasing costs.
There are signs of capacity constraints in many parts of the world, with the construction industry here in New Zealand a good example. Sooner or later, this could lead to wage pressure, as could the industrial action we’re seeing across the public sector.
Headline inflation is likely to remain deceptively low, but costs will creep higher for many employers nonetheless. Insurance, rent and rates are all rising, while regulatory and compliance costs are likely to become more of a burden, rather than less.
Some businesses are better placed to deal with this than others. Bigger firms usually weather the storm better than small ones, because they have scale.
Companies selling products that can’t be easily substituted also do well in this environment, while those reliant on consumers having more discretionary income tend to suffer.
Vector, Chorus and the electricity retailers are some that fall into the first camp, while healthcare companies are also resilient. Those more sensitive to changes to the economy, such as retailers, could find themselves in the latter group.
Strong brands tend to do well when it comes to pricing power. One global example is Apple, which has been able to consistently maintain a price premium for its products. In this regard, the next few years will show us just how strong the a2 brand is.
A weaker currency could help or hinder, as businesses attempt to demonstrate pricing power and maintain profitability. Those with export earnings might have a slightly stronger buffer to absorb rising costs.
On the other hand, companies purchasing raw materials internationally or with offshore costs could find it tougher as their purchasing power falls in tandem with the NZ dollar. A company like Sky TV comes to mind, as do some retailers.
The corporate reporting is about to ramp up in a big way across the local market. With all the talk of a slowing economy, a lot of focus will be on revenue growth trends. I’ll be watching for signs of rising costs just as closely.
This article was also published in the New Zealand Herald under the title "Mark Lister: Economic slowdown will expose weak Kiwi brands" on 6 August 2018.