Raw materials could derail the gravy chain

After the credit crunch, many companies are enjoying scintillating earnings growth, but soaring raw material costs have recently prompted to warn that margins are under pressure.

During the credit crunch, the natural inclination for companies was to batten down the hatches, cut costs, reduce debt and wait for better times. These may not be “good times” but they are indubitably “better times”, and it is not surprising that many of those companies that emerged from the financial crisis leaner and meaner are enjoying rapid earnings growth.

As earnings have grown, so has the capacity for companies to ramp up dividends. In the UK, for instance, dividend payments in the second quarter of 2011 totalled £19.1bn, up 27% on the corresponding quarter of 2010, according to figures from Capita Registrars. In the first half, dividends totalled £34.1bn, 19% up on last year, so the rate of growth picked up in the second quarter.

Mining companies alone quadrupled their pay-outs to £1.8bn, but therein lies a clue to what could derail the gravy train for companies: rising raw material costs.

Towards the end of July, a number of companies saw their share prices hit as they revealed that prospects for the second half would not be as rosy as previously expected.

Power network equipment provider Schneider Electric, for instance, complained its margins are being squeezed by rising raw material costs. The company buys in a lot of copper, silver and plastic, all of which have seen a surge in prices in recent months.

German car maker Volkswagen grumbled about rising material costs and squeezed in a gripe about the resurgent euro, as well, a theme that was echoed by French cement maker Lafarge. As for airlines, it is no surprise they are complaining loudly about sky-high fuel costs; Lufthansa and Air France-KLM both responded to higher costs by cutting back plans to increase capacity.

Companies are not completely helpless when it comes to coping with rising input costs; in theory, that is what options and futures markets are for, hedging exposure to commodities. The other major option is to pass on those increased costs to customers, which will feed through to inflation, much to the consternation of consumers.

Consumers have no one to pass their cost increases to. All they can do (apart, perhaps, from investing in dividend paying companies) to ameliorate the situation is to ask for a pay rise, assuming they have a job.

Rising wage costs will put further pressure on company margins which is, almost, where we came in …