In this article, Hilco experts from across our Valuation Services team discuss how the ongoing inflationary environment is impacting a broad range of industries from a cost, pricing and operational perspective.
Inflation was relatively non-existent for much of the last business cycle. So much so, that business leaders across most every industry and sector could be heard lamenting its absence and the lack of opportunity that existed to increase prices as a means of allowing for increased wages and improved corporate profitability. According to the Federal Open Market Committee at the time, a 2% inflation rate was deemed to be healthy for the economy. Such a predictable, manageable level meant that a healthy tug-of-war between supply and demand could exist and promote economic growth. Things, of course, would not work out quite that simply. Enter the global pandemic and the ensuing chaos.
The arrival of COVID-19 in the first quarter of 2020 cast the once vaunted supply chain of the automotive industry A Look at Continued Inflation and Its Impact on a Group of Key Industries By the Experts at Hilco Valuation Services SMARTER PERSPECTIVE: MULTIPLE INDUSTRIES into disarray. While the sentence was quick, restitution has been painfully slow. The industry has struggled to restore any semblance of balance between supply and demand. Material managers refer to it as “whack-a-mole,” the children’s game where every time one mole is chased underground, another pops up elsewhere. Chasing parts shortages has been a non-stop activity for the last 12 months. Just as soon as supply is restored on one part, the supply of another part is depleted.
As of yet, there has been no “vaccine” developed for the ailments of the supply chain and material managers will tell you that there is no category of parts that has developed an immunity. This includes the labor force. Unemployment levels had sunk below 4% prior to the pandemic and they near those levels again. Nobody is complaining about the lack of inflation anymore. The price for new and used cars have increased precipitously in the past 18 months. Retailers and distributors of parts for light-duty vehicles are reporting 3% - 5% inflation and 4% - 6% on parts for heavy-duty vehicles. Most materials managers are confident law and order will eventually be restored to the supply chain. Most human resource managers are not as confident and worry that the solution to the labor shortage is much longer-term. For now, retailers and distributors have been able to recover inflation by passing it on to the consumer. The longer that shortages exist, however, the more difficult it will be to maintain profitability.
According to the U.S. Department of Agriculture Economics Research Service, the 20-year historical average for food inflation is 2.4 percent per year. In 2020, annual food prices increased 3.4% and in 2021 they rose by 3.9%. Segments experiencing substantial increases over the last year include: Beef and Veal (+18.6%); Pork (+15.1%); Poultry (+9.5%); Fish and Seafood (+8.4%); Eggs (+11.1%); Fats and Oils (+8.8%); and Fresh Fruit (+7.9%).
Anhydrous ammonia, which is the primary source of nitrogen fertilizer, increased substantially in 2021 based on reporting from Data Transmission Network. While the 5-year average price was around $500 per ton, prices increased to all-time highs of $1493 per ton in January 2021. According to Reuters, prices are at record highs “due to the soaring cost of the natural gas used to produce them, and severe storms that have disrupted production.” The cost of fertilizer is a crucial input cost for corn and wheat prices. The U.S. is the largest producer of corn in the world, and approximately half of U.S. corn production is actually used for animal feedstock. As a result, large price increases escalate costs dramatically and have wide-ranging implications for food supply. Case in point, because these increases in fertilizer costs also impact which crops farmers plant, this can result in farmers planting less fertilizer-rich crops such as soybeans. Additionally, in recent weeks, wheat prices have skyrocketed as well. Russia and Ukraine combined account for nearly one-third of the world's wheat and barley exports. The products they supply are made into bread, noodles and animal feed across the globe.
From a labor perspective, costs have increased as well in many areas and the pandemic has driven many workers away from restaurants, most of which are currently experiencing staffing shortages as a result. Demand for warehouse workers within the food industry also remains high, although, admittedly, under the most normal of circumstances it is rare for us to visit any warehouse and see it fully staffed. As widely reported, gas prices have risen even further in response into current world developments and the cost of importing product from overseas continues to run high, as food companies require added working capital to pay for more expensive containers and account for inventory stuck in port due to supply chain challenges. Even though these and other costs are rising, some food producers with high demand have been able to pass them on to customers and improve profitability, even with many plants at only around 80% of capacity. On the retail side, food chains such as Starbucks and McDonald’s are also taking the path of increasing customer prices to account for cost increases. Foodservice is still recovering, but is much improved from 2020.
We expect to see increasing fertilizer, transportation, and labor costs continue to drive up prices in 2022 for meats, dairy, fruits/vegetables, and other food categories.
The home furnishings industry has been experiencing notable inflationary pressure stemming from a few primary factors, including insufficient manufacturing capacity, increased freight and raw material costs. Employers, struggling with worker shortages, have had to raise wages as an incentive to keep existing employees and attract potential new candidates. With smaller workforces, production capacity is reduced. Freight container shortages have led to a substantial increase in container prices, forcing retailers, wholesalers, and manufacturers to “bite the bullet” and either pay the increase or jeopardize future sales and customer relationships based on a lack of inventory available for sale. The freight issues, however, do not end with these costs. Once a container finally does arrive at its destination port, further delays are occurring with offloading the vessel (staff shortages) and getting the containers on trucks to be delivered (driver shortages). In an effort to offset these ocean freight delays, some companies have resorted to air freight, which, of course, comes at a hefty price. In terms of raw materials, there has been continuous increases in the cost of lumber, metal, foam and cotton, the primary base materials used in home furnishings (i.e., furniture, décor, and towels).
The factors above are, in turn, leading to increased product costs. In most cases, these are being passed on to the consumer, although some retailers, wholesalers, and manufacturers are working with suppliers to split the higher costs, so these increases do not have to be borne by their customers and consumers. Prices are going to continue to escalate until demand is brought back in line with supply, either through slower demand growth, faster supply growth, or a combination of the two.
Home furnishings retailers continue to suffer from a lack of inventory and long lead times.
Market prices for softwood lumber have been on a wild ride since COVID struck the U.S. back in early 2020. During the initial months of the pandemic, when new home construction was deemed an essential activity, demand for lumber remained robust. That demand only increased as people began to remodel their homes and looked for larger residences amid the work from home environment and the desire to socially distance. Although slowing slightly over the past six months, the housing market remains robust and demand for lumber continues to run high. Supply of lumber, however, has remained relatively limited over the last couple of years with companies along the supply chain struggling to maintain enough staff amid the initial COVID wave and subsequent delta and omicron variants. Market prices for softwood lumber normally range between $250 and $450 per thousand board foot (MBF). Since June 2020, however, the floor for softwood lumber has been $450 per MBF and prices have reached as high $1600 per MBF in June 2021. Recent lumber prices hit approximately $1200 per MBF, nearly triple the level that would have been considered strong only a few years ago.
Sawmills are taking the overwhelming majority of the lumber price increases to the bottom line as the increase in the price of logs has remained relatively muted. The largest beneficiaries have been sawmills processing pine in the southern part of the U.S. After years of overplanting pine plantations, landowners are not able to gain advantage of the highest lumber prices on record. While prices for logs have increased more in other parts of North America, namely Canada, sawmills in those regions are still enjoying record profit margins.
Market prices for most steel increased rapidly in 2021 as the effects of the COVID-19 Pandemic waned. Prices peaked in the fourth quarter of 2021 and have since decreased, but remain significantly above pre-Pandemic levels. While most steel product pricing had trended downward or was flat prior to the start of the Pandemic, its arrival disrupted demand for auto and other industrial goods, and in turn basic steel products. Uncertain of demand, producers and distributors reduced their inventories throughout the supply chain and steel mills significantly reduced output.
As economies around the world expanded in the later part of 2020, demand increased while the depleted supply chain and fierce competition for resources resulted in increased market prices. Producers that had historically been exporters were now selling more within their own borders. Meanwhile, the residual effects of the Trump-era tariffs, longer shipping lead times, and significantly higher export cargo prices all combined to discourage imports into the U.S. These decreased imports along with higher import prices, allowed domestic producers to increase both their output and their prices.
While it is likely that steel market prices will continue to decrease, they are likely to ultimately stabilize well above pre-pandemic levels.
While the economy was expanding, consolidation of the steel industry continued. Cleveland Cliffs, which historically operated as an iron ore mining company, purchased AK Steel and ArcelorMittal’s U.S. operations, thereby combining two of the country’s largest steel producers. Other consolidation occurred, including U.S. Steel’s purchase of Big River Steel, which served to further reduce price competition among domestic producers. Not surprisingly, costs associated with steel production have increased during this period. Iron ore, metallurgical coal, energy, labor and other costs all increased in 2021 and remain at higher levels. While it is likely that steel market prices will continue to decrease, they are likely to ultimately stabilize well above prepandemic levels.
Like steel, aluminum output also decreased during the Pandemic and then demand outpaced supply as the world economy expanded. China, the world’s largest producer, decreased production to control pollution and Co2 levels, further decreasing world supply. It is also worth noting that in 2021, the three largest exporters of aluminum were Canada, Russia and the United Arab Emirates. Russia’s current invasion into the Ukraine could bring embargos on Russian aluminum, further escalating aluminum pricing.