Deflationary Pricing Pressure Causing Corporate Cutbacks

From consumer goods to industrial behemoths, downward pricing pressure on corporations is forcing them to hold or even lower costs.

The result is affecting the capital markets, particularly as stock values decline; as well as executive compensation formulae and resource allocations decisions.

The primary causes of the deflationary trend appear to be two-pronged: cost-conscious consumers whose stagnant household incomes in the developed western economies are forcing them to make choices between a range of products and services, not all of which they can afford any longer; and global competition, especially from Asia, as the slowdown in global consumer purchases is causing lower volumes of production and retrenchment.

In order not to have to shut facilities and lay off workers, a politically sensitive move in any nation, but especially China, managers are lowering costs and taking losses in hopes that they will drive their western competitors out of business in hopes they will be able raise prices in the near future.

Concerns about these developments are especially acute because they are not limited either to industrial or consumer sectors: they are comprehensive, widespread and persistent.

Corporate executives, particularly in the US, have been accumulating ever greater cash reserves due in large measure to their reluctance to commit funds which may not produce returns that the algorithmically traded markets demand. The managerial fear is that less than outsized results will put further downward pressure on equity prices and on compensation calculations. The problem, however, is that the failure to invest in innovations is driving the market to compete primarily on price rather than on features like quality or function, creating a glut of undifferentiated offerings - and self-fulfilling prophecy with regard to returns and growth. JL

Theo Francis reports in the Wall Street Journal:

American companies are struggling with falling prices for a number of their key products amid intense competition and pressure from cost-conscious customers.

Executives from companies as varied as General Electric Co.  GE in Your Value Your Change Short position , Kimberly-Clark Corp.  KMB in Your Value Your Change Short position and Royal Caribbean Cruises Ltd.  RCL in Your Value Your Change Short position said some prices slipped in the last three months of the year—sometimes significantly.

Falling prices for adhesives weighed on Eastman Chemical Co. , cheaper packaged coffee dragged on Starbucks Corp.  SBUX in Your Value Your Change Short position , and "value and discounts" hit McDonald's Corp. in the fourth quarter in what the fast food chain called a "street fight" for market share. Xerox Corp.  XRX in Your Value Your Change Short position is eyeing acquisitions that can "help us be more competitive on price pressure."

Corporate revenues are showing the strain, whether from lower prices, weak demand or a combination of the two.

With about half of companies reporting year-end earnings, Thomson Reuters estimates revenue for companies in the S&P 500 stock index rose just 0.9%—capping two years of lackluster revenue growth and tying the third-weakest quarterly sales growth since the fall of 2009. Part of the problem is that weak revenue leads companies to cut prices to boost sales, which reduces the value of those sales, and trickles down through the supply chain.

The persistent weakness in revenue also prompts companies to cut back costs and plow their spare cash into share buybacks instead of investments like new factories and hiring. Fourth-quarter earnings, as a result, are expected to be up 9.4%.

"When you have such weak top-line growth, such weak demand, the competitive environment becomes much tougher," says Jason DeSena Trennert, chief investment strategist with Strategas Research Partners. "One of the ways to compete for top-line is through price."

Not every company reported price drops. 3M Co. said prices increased 1.4% in the fourth quarter, attributing the gain to research gains and adjustments made in emerging markets designed to offset currency devaluation. Harley-Davidson Inc. said price increases helped boost motorcycle revenues by 1.4% in the quarter even as shipments fell 1%. Altria Group Inc. MO in Your Value Your Change Short position said a 13.2% rise in income for cigarettes and cigars in 2013 came "primarily through higher pricing."

But the trend is evident in government data. While economic growth in the fourth quarter came in strong, helped by expanding consumer spending, firms aren't raising prices. For the last two years, the consumer-price index has increased less than 2%, the first time in 15 years it has been that low in consecutive years. And in the year since December 2012, the consumer-price index for goods, excluding food and energy, declined 0.1%.

The pressure on prices isn't ubiquitous, instead cropping up in certain markets or business lines. For instance, low Arabica coffee prices last year at one point prompted Starbucks to follow competitors in cutting the price of the beans it sold in groceries to $8.99 from $9.99 for a 12-oz bag; but the company kept prices stable for single-serve coffee.

Take the business of blood. Hospitals are squeezed by shrinking reimbursements, rising costs and a rapidly changing health-care system, so hospital executives are making cuts like paying less for their supplies. That means Haemonetics Corp.  HAE in Your Value Your Change Short position , which sells needles, tubing and other equipment for collecting and transfusing blood, has to lower its prices to win business.

"It's coming all the way down the chain from the hospital that's under cost pressure, all the way down to us," said Gerry Gould, the company's vice president for investor relations. "We now have to go and see what we can do to reduce our cost."

Major customers are increasingly seeking to control supply costs with single-source competitive bids. In January, Haemonetics said it won an exclusive three-year contract from a group of blood-donation centers, boosting its market share significantly. But price concessions mean the deal will pinch margins in fiscal 2015. Another pending bid also includes price cuts, the company said.

Pressure on prices is also coming from consumers, who continue to seek out discounts on basics even as they occasionally splurge on products they really want. Kimberly-Clark reported soft prices in parts of its North American personal-care business last quarter due to discounting. The maker of Huggies diapers and Kleenex tissues also noted that competitors lost market-share in the facial-tissue business to lower-cost private-label products.

"We wanted to be a bit more competitive on shelf every day, and so you saw a negative price," said Kimberly-Clark Chief Executive Thomas Falk.

The downward pressure is likely to continue, a company spokesman said, though Kimberly-Clark saw its own market-share for tissues hold steady and hopes to "help negate" baby-care price cuts with previously announced plans to reduce the number of diapers in packages of Huggies.

Elsewhere, the culprit is global competition. Leggett & Platt Inc.,  LEG in Your Value Your Change Short position which makes bedsprings, carpet pads and other goods, was selling steel rods for less as steel prices dropped. The Carthage, Mo., company blamed "steel-related price deflation" for about half of an 8% decline in same-location sales for its industrial metals business over the full year.

The company said prices for its steel rod and steel wire products fell in the early part of the quarter, because steel rods were "flooding into the country from primarily China and Turkey." Although the excess supply drove prices down, domestic scrap prices remained steady, the company said. Other products, including carpet padding, saw prices increase.

The U.S. benchmark price for steel rods and other long products has fallen to $632 from $641 since Oct. 1, amid a 14% rise in imports of such products, even as prices for other forms of steel have increased, according to data from Platts, the provider of commodities information.

A Leggett & Platt spokesman declined to comment.

Plenty of companies are pointing to softness in at least some of their products. Honeywell International Inc. said depressed prices for a specific refrigerant will continue to impact results through the first quarter. Airgas Inc. faced the same coolant issue, leading to a drop in sales for the quarter.

GE cited pricing pressure in its key gas turbine business in the fourth quarter, at a time of slack electricity demand in developed markets. GE won big contracts in Saudi Arabia and Algeria in the quarter but total order prices for heavy duty gas turbines were down 4% in the fourth quarter.

And the company doesn't appear to expect a recovery in prices any time soon: It said it plans to maintain the turbine business's profitability by reducing its own costs. Heavy duty gas turbines "probably had the most intense pricing pressure," GE Chief Executive Jeff Immelt said. "But we have a very active plan to get about 10% of the cost out."