Tuesday, November 8, 2022

Calcbench has written about inflation numerous times over the course of 2022. Today we want to take more of a big-picture view: how is inflation affecting corporate revenue, expense, and earnings across a large population of companies?

After all, inflation drives up costs — but as companies pass along those higher costs to customers (which they’ve done with increasing frequency in recent months), then inflation should also push up revenue, right? And would that also give companies more ability to protect earnings?

To answer such questions, we did a quick review of the collective performance of roughly 1,700 non-financial firms. Right now the picture is decidedly mixed.

Figure 1, below, is that picture. It shows the year-over-year change in 12 common financial metrics, comparing Q3 2021 to Q3 2022. It shows us that revenues are up 14.8 percent, which is more than the roughly 8 percent annualized inflation we’ve seen lately. Then again, cost of revenue (typically raw materials and components) rose even more, by 16.9 percent.

Ultimately, however, net income fell 5.3 percent — so to whatever extent companies are passing along their higher costs to customers, that effort hasn’t preserved earnings growth yet.

In fact, the situation might even be worse than Figure 1 suggests. We broke out earnings specifically from large oil & gas companies, to see how much their outsized earnings in Q3 propped up the whole 1,700-firm sample. The results are in Figure 2, below.

Oh dear. Aside from oil & gas firms and the gobs of profit they just reported, earnings for Q3 2022 were actually even worse than that -5.3 percent in Figure 1. The stunning performance of the oil & gas sector is keeping Corporate America’s collective net earnings afloat.

We should stress that these numbers are a work in progress. Lots more firms still need to file their Q3 reports, including major retailers such as Walmart ($WMT) and Target ($TGT). Retailers do give a good sense of how much companies can push their higher prices to consumers, but they also work on a later fiscal schedule, which means we won’t see their Q3 data for a few more weeks yet. Calcbench will publish a more complete report once all that data is in hand.  

One Specific Example

One interesting example of the challenge facing companies right now is Shake Shack ($SHAK), which filed its Q3 financial statements the other week. Year-over-year revenue rose by a brisk 17.5 percent, but expenses rose by 18.4 percent. So the company ended up with an operating loss that nearly doubled, from $2.64 million one year ago to $4.83 million for the period that just ended. See Figure 3, below.

One question analysts might want to ask is the extent to which a company might revisit some of its expense items to keep operating profit high. We are not necessarily talking about fraud, but rather — which expense items could be squeezed for more savings, and how?

For example, Shake Shack reported a $592,000 impairment charge; will that be the case in future periods? Or, Shake Shack’s labor expenses rose 11 percent from the year-earlier period; will management implement a hiring freeze or layoffs? Do those issues come up in the earnings call?

We only cite Shake Shack because it provides a detailed look at its expense items (plus we like their shakes). It demonstrates the point that the disclosures companies provide can help you focus your analysis and sharpen the questions you might want to ask management.

The story about inflationary pressures is there, and it’s a big one; the details are simply — and as always — in the data.  

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