Navigating a Minefield: Difficulties in Today’s Environment and How CFOs Can Avoid Danger
Between international conflict, energy shortages, inflation, interest rate hikes, and volatile commodity prices, business leaders (especially CFOs) are trying to keep up with a whirlwind of variables impacting market conditions. To help, we’ve summarized the key factors impacting today’s macro environment and offered a few points of guidance for CFOs who want to avoid pitfalls in investor messaging that could impact their company’s stock.
Supply Chains Are Still in Limbo
One in five container ships are stuck at ports worldwide, with 30% of the backlog coming from China. Shanghai, home to the world’s largest container port, is emerging from lockdown after having been shuttered since March 28th (although the port has remained in operation during the lockdown).
While Chinese operators coming back online could help ease supply chain constraints over the long term, U.S. experts anticipate international freight will be stretched thin in the near term as Chinese companies rush to churn out backlog. This could overwhelm ports on the west coast of the U.S., which are already facing staffing shortages. Experts anticipate this pending supply-chain crunch to last all of 2022 once it begins.
At the same time, rising wages have brought truckers back to work in the wake of the COVID-19 pandemic, but the global trucking industry is now facing a shortage of trucks and trailers, prolonging logistics constraints. Global shipping costs have fallen somewhat since rising exponentially between Q1 2020 and Q4 2021, but currently remain well above pre-pandemic levels.
Despite this relative decline in shipping costs, the rapid increase over the past two years has created a ripple effect. According to the IMF, inflation picks up by 70 basis points each time freight rates double, equating to a 1.5% increase in inflation during 2022.
All signs point toward sustained supply chain and logistics obstacles through the remainder of 2022. While companies have mitigation strategies available (through manipulating inventory and pricing levels, for instance), these costs will add pressure on operating margins.
Commodities Are Volatile but Generally Trending Up
As earnings season has kicked off, cost inflation has been a common theme. The automotive industry was amongst the first to cite this impact, with Continental AG reducing full year earnings guidance due to “negative effects from cost inflation for key inputs, especially for oil-based raw materials.”
Iron and steel prices remain off of historical highs reached in mid-2021, ticking back up after falling dramatically towards the end of the year. Aluminum prices have surged again since Russia’s invasion of Ukraine, nearing mid-2021 levels. Despite the price decline in Q4 of 2021, many products sold in the first quarter of this year were built with materials purchased while metal prices were near all-time highs.
Energy prices, including natural gas, crude oil, gasoline, heating oil, and coal, jumped in March following the Russian invasion of Ukraine as countries worldwide worked to cease reliance on Russian petroleum and natural gas exports, leaving many countries vulnerable and undersupplied. Coal usage, already on the rise in 2021, continues to rebound, with countries including Germany considering reactivating decommissioned coal-fired power plants to secure energy for the next winter. With no near-term solution in sight, high energy prices will likely remain a global operating headwind for the foreseeable future.
Interest Rates Haven’t Slowed Spending…Yet
With the Fed’s initial 0.25 point interest rate hike in mid-March, the first since 2018, a second 0.5 point hike last week, and potentially several more to follow, the cheap money faucet is shutting off for both companies operating in America and the average American citizen.
For businesses, borrowing will become more expensive, leading to new debt issuances or refinancing existing debt prior to the next rate hike. Highly-levered businesses will feel the pinch first, as increased interest expense hits the bottom line and potentially disrupts operating cash flow. Further, the rate of M&A may decline as cost of capital increases, making large deals more costly.
The average U.S. consumer may move away from big-ticket items, as both inflation and interest rates make financed purchases less advantageous. General spending does not appear to be taking a hit, though. Consumer packaged goods behemoth Procter & Gamble raised full-year top line estimates owing to price increases enacted to mitigate the impact of rising input costs. P&G cited price elasticity “in-line or better than expectations,” and demand for premium offerings (presumably the first products that price-sensitive consumers will cut from their budgets) remaining strong.
What Does This Mean for CFOs and Their Teams?
Despite optimism as 2021 closed, headwinds stemming from supply chain constraints have not eased, and many input costs have only risen since the start of the current year. Companies impacted by these headwinds – or those with full-year outlooks built on anticipated recovery in the second half – are prone to downward guidance revisions.
- Isolate the Obstacles: CFOs and their teams should be careful to not imply that a downturn in Q2 is necessarily indicative of slowed growth across the quarter. Balancing short-term headwinds with longer-term tailwinds is a key part of telling a compelling investment narrative.
- Put Away Your Crystal Ball: It will also be critical to avoid questions surrounding a second half economic recession. Even when they’re right, corporate leaders are not rewarded for being the canary in the coal mine. It’s important for CFOs to remain patient and ensure that their talking points – especially during earnings calls – are not out of line with the broader market. Focus talking points on what can be accurately predicted and outline the leading indicators that the business looks at.
- Focus on Business Resilience: While CFOs should avoid doom and gloom messaging with respect to the macro environment, there is a way to inform analysts that your business is prepared, nonetheless. CFOs should underscore the durability of their company’s business model and the strategic levers that management can pull to effectively protect margins, even in a downturn. This may include things like pricing and cost recovery strategies, tactics for reducing input costs, efficiency enhancement initiatives, and more.
If you could use some help on your messaging or want to avoid sending mixed signals to the investment community, give us a call. We can help you build a well-balanced narrative and help coach your senior management team to stay on track with a story that will resonate with investors.Back To Blog