Wednesday, May 17, 2023

Now that we have a significant supply of Q1 2023 filings in hand, we wanted to revisit inflation again, to see whether retailers have enough pricing power to pass along higher prices to consumers.

The theory here is simple. Yes, the cost of raw materials and labor jumped by painful amounts in 2022 — but if companies could then pass along those higher costs to customers, the companies could preserve operating margins. Right?

To test that thesis, we compiled a list of 61 retailers that have already filed their Q1 2023 financial statements; everyone from Albertsons and, to Dillards and Home Depot, to Sonic Automotive and Then we examined their quarterly revenue, gross profit, operating income, and net income for the last three years (that is, from the start of the pandemic until now).

The data tells an interesting tale. Altogether, gross margins (revenue minus cost of goods sold) have held remarkably steady even as companies swung from lockdowns to pandemic-recovery splurging to inflation. Operating margins (profit before interest and taxes) tumbled notably in 2022. And net profit margins (you should know what that is already) bulged upward in 2021, fell sharply in 2022, and have barely begun climbing back upward today.

Let’s start with gross profit. Figure 1, below, shows the collective gross profit margin for our retailer group.

Talk about steady! We’ve hung picture frames less level than the line above. Across all 13 quarters we examined, gross margin only fluctuated from a low of 26.3 percent (Q1 2020) to a high of 27.9 (Q2 2021). Gross margins in the last six months have been hovering near that 27.9 percent high.

OK, that’s one data point to support the thesis. What about operating margins? See Figure 2, below.

Clearly operating margins are much lower than gross margins. More than that, however, operating margins did feel more of inflation’s pinch, especially in the latter half of 2022. (The blue line is operating margin quarter to quarter; the red line is the overall trend.) For example, operating margins went from a heady 6.9 percent in mid-2021 to a low of 1.9 percent in Q3 2022. That was when the effects of inflation, which had started to accelerate several months earlier, had seeped into the economy as a whole.

So that’s one data point against our thesis. Could net income be the tie-breaker? See Figure 3, below.

Yuck. Net margins were even more volatile for our peer group. They fell to a low of only 1 percent in Q3 2022, and while margins are accelerating back upward now, the red trend line is still on a steeper downward slope than the operating margins in Figure 2.

At least for our sample of 61 retailers, then, perhaps the “pass along thesis” about costs isn’t so strong. The above charts all look at the margins collectively, for all 61 firms together; but we ran a similar analysis for average gross, operating, and net margins, and came to the same results.

Maybe a larger pool of retailers, or other industrial sectors, would tell a different story. We’ll keep looking into things, but the data above tell the tale that they do.

Where to Go From Here

Financial analysts could go in several directions from here, as you try to discern what the future might hold.

For example, one big determinant for net income is interest expense — and last time we checked, interest rates were still going upward. So for whatever firms you follow, you’d be well-served to examine their debt levels and whether those firms will be refinancing old debt any time soon. If they’re likely to refinance at higher interest rates, that’s going to squeeze net income. (If you want to geek out on debt disclosures, be sure to review our in-depth series on corporate debt levels from earlier this year.)

Second, another big driver of margin pressure is personnel costs. Those costs are typically reported in the Sales, General & Administrative line, after gross profit. So ask: is this retailer a tech-centric firm, such as Amazon or Wayfair, where they might have over-hired in 2021 or still struggle to hire good coding and engineering talent? Or are they more brick-and-mortar focused, where labor might still be scarce, but the company is paying hourly wages rather than sky-high salaries?

Calcbench has all that data to perform further analysis, of course. Let us know what we should research next!

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