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Tuesday, April 20, 2021

Cost pressures are the hottest topic on earnings calls

First quarter earnings season is less than a week old, but the biggest theme management teams are talking about is clear — higher costs.

On Monday morning, Coca-Cola (KO) served as the week's first Blue Chip company to report its quarterly results. And the impact higher costs could have on the business were a notable part of the conference call conversation.

"Last quarter, we said that despite a rising commodity environment, we expected a relatively benign impact in 2021, given our hedged positions," Coca-Cola CFO John Murphy told investors Monday morning.

"While this continues to be the case, we're closely monitoring upward pressure in some inputs such as high fructose corn syrup, PET, metals, and other packaging materials as they impact us as well as our bottling partners." (Emphasis ours.)

Later in the call, Murphy said in response to a question on costs that higher commodity prices are likely to be "more of a headwind [in 2022]." Murphy added Coke "typically [looks] to take pricing in with inflation."

In other words, Coke will not be aggressive in raising its prices beyond what broad economic trends dictate. But as many readers are no doubt familiar, the inflation picture into the second half of this year is likely to look quite unique. More widespread vaccinations, loosening COVID restrictions, pent-up demand from excess consumer savings, and supply shortages ranging from service sector labor to vacation rentals are likely to push prices higher across a wide range of goods and services.

The Federal Reserve and many economists have talked at length about these pressures being transitory, one-off events need not put inflation on a new, faster trajectory. Whether Coca-Cola and other corporates that benchmark pricing increases to economy-wide inflation trends will see these pressures as transitory or an opportunity to raise prices by the most in decades remains to be seen.

Market strategists are also looking closely at the discussion management teams are having on higher costs so far this reporting period. In a note to clients published over the weekend, Morgan Stanley strategist Mike Wilson writes that, "Early in earnings season, cost pressures have emerged as a prominent topic of conversation.

"This development is corroborated by a number of macro data points which suggest that a range of expenses are on the rise," Wilson adds. "Pent-up demand due to the pandemic and elevated household savings suggest price increases in certain end markets may be digested initially, but for how long? While it's premature to draw conclusions around corporates' ability to pass on costs into the reopening, we think this is a potential risk to margin expectations worth monitoring."