24/7 Wall St. has decided to investigate where inflation has the greatest potential to damage the economy.  There is plenty of ground to cover. It is clear that the cost of agricultural commodities, metals, and oil have risen substantially over the last six months, but many of those increases have not yet reached the consumer. “If raw material costs have yet to translate into consumer inflation, it is partly because high unemployment in developed markets makes it hard to raise prices,” said Oliver Pursche, co-manager of the GMG Defensive Beta Fund, on Newsmax.com. It is unfortunate that joblessness has a prophylactic effect on consumer price levels.

While inflation may lurk in some sectors of the economy, there are products and services that Americans use, like Google’s (NASDAQ: GOOG) search features and Citigroup’s retail banks, which are unlikely to be affected by inflation at all. The prices of these are not likely to rise because there are no major costs of goods to pass on.

Inflation in the United States has not approached the level that it did in the mid 1970s and early 1980s when interest rates rose to 20%.  Most economists believe that the Federal Reserve today has the foresight and tools to prevent a repeat of the price bubble of that period. That may be so, but the Fed cannot protect consumers from rising oil prices when they fill up their gas tanks or buy an airline ticket.

24/7 Wall St. took into account two effects that inflation has on an industry. The first is what the higher cost of goods means to their expenses. The other is whether companies in the industry can pass these costs along to consumers – either individuals or other businesses.

Rising prices are hurting many industries including retailers. Shoppers may reject higher prices and cut back spending to preserve their household budgets. Retailers will face margin compression if that happens. Earnings in the industry will be hurt, and in some cases this will be enough to cause layoffs.

The challenge is not unlike the one that the air freight industry faces. FedEx (NYSE: FDX) and UPS (NYSE: UPS) have raised rates to offset higher fuel prices. Each company has been able to increase shipping rates without alienating customers. The impact of this decision will not be clear until the companies announce second quarter earnings.

One advantage that many businesses have is that the effect of inflation on costs consumers must pay often lags. Large retailers probably have inventory which was made a number of months ago.  Temporary price increases in cotton and wool may not affect earnings if the period of inflation does not last long.

The commodities which have increased in price over a long period and for which there is great demand are not likely to fall soon. Oil is up, but not only because of trouble in the Middle East. Demand from China, the largest net importer of oil, continues to rise. The economic recovery in the US and Europe has naturally increased demand for gas, heating oil, and petrochemicals just as the recession decreased it.

Price for some agricultural commodities will stay high. Wheat production in Russia and China has been badly undermined by drought. It will take more than one planting season to reverse that. Another year of drought will make the situation much worse.

Apparel companies may be among the first groups this earnings season to highlight cost pressures because of the near-doubling of cotton prices last year. Still, clothing made with higher-priced cotton likely will not hit stores for six months or more, said Al Ferrara, national director of BDO Seidman’s retail and consumer product practice, in an interview with Reuters.

The 10 industries that 24/7 chose for this analysis were ones where it seems that the effects of inflation on their costs of goods will be long-lasting. Companies in these sectors will not escape sharp price increases in the core components they use to build the goods they sell. These firms may have to struggle with rising costs for several years.

1. Air Transport
The increase in oil prices is causing a rise in jet fuel prices, hurting earnings for many airline companies.  The NYSE Arca Index, which tracks major airline stocks, was down more than 5% on February 22, 2011, with all 13 companies included on the index moving lower.  Delta Airlines (NYSE: DAL) recently warned that increased fuel costs could hurt its earnings for the balance of the year.   Companies such as American Airlines (NYSE: AMR), United, Continental, U.S. Airways (NYSE: LCC), and Delta have increased the prices of most round-trip tickets to domestic destinations by $4 to $10, according to website FareCompare.com.

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2. Food Retail
Rising food commodity prices are passed on from the wholesale food industry to retailers, which must then bear the burden.  Kellogg (NYSE: K) has faced higher grain prices. In response, the company announced that it will raise its cereal prices 3% to 4%.  Coffee prices are also up, prompting Starbucks (NASDAQ: SBUX) to announce that it would increase prices on larger drinks and drinks which require extra labor.  The same is true with Sara Lee, which sells Senseo coffee.  Higher corn prices affect the costs of many other foods, including meat, which is used for animal feed. This in turn adds margin pressure to companies like McDonald’s.  In November, Wal-Mart said that it expected “very moderate” inflation, but that it would be difficult to increase prices because of weak demand.  Other grocers, such as Safeway Inc. and Krogers, have said that increased supplier costs will be passed directly on to customers.

3. Apparel
The clothing industry is facing problems related to costs of basic apparel commodities.  Wool and leather prices are both up. Cotton, which is up 36% this year, is selling near its highest prices in more than a decade.  Upscale retailers Polo Ralph Lauren (NYSE: RLP)and Brooks Brothers both plan to raise prices.  The same is true for Jones Group Inc, which sells clothing under the brands Nine West, Anne Klein, and Jones New York.  The more moderately priced Hanesbrands, which has already raised prices due to the cost of cotton, has said that it will increase prices again towards the end of the summer by as much as 30%.  Abercrombie & Fitch (NYSE: ANF) said during its last earnings call that it had been able to pass increased costs on to its customers.

4. Appliances
Due to the soaring price of steel, producers of appliances are having to find new ways to make up costs. Whirlpool, which markets products under the brands Maytag and KitchenAid, has cut jobs, shut down plants, and moved manufacturing out of the United States.  Its raw material costs are expected to grow this year to between $250 million and $300 million, compared with 2010’s $217 million.  Swedish company Electrolux faces a similar situation, and has reported plans to raise prices in North America by 8% to 10% starting in April.

5. Newspapers
As if the newspaper industry needs more money troubles, the price of newsprint has increased due in part to the increased cost of timber. This, combined with consistently decreasing circulation and ad revenue, has made printed newspaper seem less and less practical.  A. H. Belo, one of the largest newspaper chains, recently reported an increase in newsprint expense of 26.7% for the fourth quarter, compared to a year prior.  This is despite the fact that there is only a 6.2% increase in newsprint consumption. According to the company, costs of printing per metric ton increased 19.3%. The New York Times Company and Gannett Co., the largest largest newspaper company in the United States, have announced that they face similar difficulties.

Also Read: Will The iPad 2 Come Too Soon?

6. Consumer Products
Many companies within the consumer products industry had deteriorating earnings in the last quarter.  For the quarter ended December 31st, Procter & Gamble posted a profit of $3.33 billion, down from the $4.66 billion posted a year prior. Procter & Gamble’s prices for production materials and energy were up more than 20% compared to last year, according to the company.  Its last quarter earnings fell in its division which makes Crest toothpaste and its division which makes Tide and Cascade.  Procter & Gamble plans to make up for rising production costs by increasing prices on some products in the United States, such as Duracell batteries.  It also plans to increase prices on other products in countries including Venezuela and India.  Colgate-Palmolive, which has also faced rising costs, has said that it will raise prices 1% to 2%.  Kimberly Clark Corp., which owns Scott Paper Company, has already made cuts by decreasing the size of its toilet paper squares.

7. Enterprise Shipping
According to AAA, the average price of regular gas is $3.171/gallon, compared with $2.648/gallon one year ago.  This increase has had significant impact on shipping companies.  These companies are also plagued by the same jet fuel issues as the airlines.  On January 3, 2011, FedEx increased its shipping rates on ground and home-delivery services by an average 4.9%.  United Parcel Services (UPS) similarly raised rates on domestic ground and air express shipments by 4.9%.

8. Mining
Although revenues are high for gold, miners have been extremely high lately, thanks to the metal’s current prices, operating costs are rising for miners.  The increasing costs of oil and steel, both of which are needed for mining, are driving operating costs up.  Barrick Gold, the largest gold mining company in the world, recently reported that operating costs for 2011 will be 10% to 25% more than previously indicated due to labor, freight and commodities.

9. Petrochemical
The petrochemical industry has suffered due to increases in the cost of petroleum-based raw materials and rising transportation costs.  DuPont announced a 15% drop in net income in the most recent quarter as a result of the rising cost of supplies.  The company stated that raw material costs were up 6% for 2010 from 2009.  DuPont expects these costs to increase even further this year.  Dow Chemical Co announced a $685 million jump in expenses for crude oil and other raw materials in its most recent quarter. The company has stated that it will pass these additional costs onto its customers in 2011.

10. Consumer Electronics
The rise in oil prices, fueled by global unrest in Egypt and now Libya, will likely lead to an increase in component costs due to rising transportation expenses.  Additionally, materials such as plastics for computers or chemicals used in cell phones will increase in costs as petrochemical factories are forced to pay more.  Tech stocks already reacted badly in response to petroleum’s rise over the President’s Day weekend, with a 2.6% drop compared to a DJIA decrease of 1.4%. Earlier this year, companies like Sony and Dell took a hit when China began a crackdown on illegal mining operations – reducing their exports of rare earth minerals, which are necessary for many electronic components.  Unless production costs drop, consumer electronics prices will only further increase.

Charles Stockdale, Douglas McIntyre

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