This year could be the year of the Great Recovery as industries battle back from a tough 2020. There are big earnings growth expectations in the areas of consumer discretionary spending, energy, financials, industrial, and basic material.
However, while the recovery is in motion, businesses are facing pressures in the areas of supply constraints, elevated input costs and labor shortages. How they deal with this margin pressure will reflect on their 2021 earnings statements, and beyond.
Smart Business spoke with Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank, about the macro-economic factors businesses should be watching as they work through what should be a recovery year.
What’s driving inflation concerns?
The components to inflation are commodities, wages and owners’ equivalent rent. Wages and real estate have been fairly well-behaved, maybe slightly elevated. But the reason for this spike in inflation is because commodity indexes are up 66 percent over the past 12 months.
The Federal Reserve thinks this spike in inflation will be transitory, but that’s not necessarily the consensus view. Companies have pricing power and keep raising prices, and wages are going up at the low end, which also could continue. Together, these factors have the potential of making inflation stickier than the Fed thinks it will be.
The Fed has also expressed that this inflation can be attributed to the reopening of the economy, causing supply chain and labor concerns — labor not being at the right place at the right time. The sense is they think once companies sort out those supply chain issues and labor gets back to where it needs to be, which they expect will be by the fall, inflation will move noticeably lower, back to the 3 percent range from the current 6 percent range.
What’s happening with commodities and labor?
Most businesses are buying additional supplies of the commodities than they use — buying three months’ worth rather than one. That’s a normal reaction to inflation, which at the moment is very broad-based. Many continue to wonder when prices will come down enough that businesses stop hoarding.
Part of the labor shortage can be attributed to a mismatch between the skills needed and the skills workers in the market have. This is especially prevalent in the goods-producing industries where U.S. consumers have continued to spend in robust amounts.
The focus of labor is now in the service industries as they reopen. Many former service-sector employees moved to the goods sector over the past year and may not return. That’s why many companies in the reawakening service industries find themselves in a position in which they need to find machines to replace the shortage of labor.
Something else to watch, the Bureau of Labor Statistics’ June JOLTS found that more than 3.9 million employees voluntarily quit their jobs in April. This is, by far, the largest number for this data series started in 2000. So now not only do companies have to spend resources to recruit, they’ve got to spend resources to retain.
What should businesses discuss with their bankers?
Businesses are keeping a close eye on their revenue versus margin. Revenues generally are increasing now, but margins are tightening because of input costs, supply constraints and labor shortages. Much of the conversation is around whether revenue increases are offsetting the margin increase and how long that can be sustained.
Businesses also want to know if their balance sheet is in the right place now that they’re on the other side of the pandemic. They should look to take advantage of low interest rates and lock them in, then look ahead to ensure they have enough cash flow to cover the potentially increased level of debt.
There is a lot to be optimistic about. But margin pressures are enough of a concern that businesses should talk with their banker about all three financial statements — earnings, cash flow and balance sheet — to ensure they’ve got strategies in place to profitably grow over the coming years.
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