Blue chip stocks already facing drastically slowing profit growth, if not already experiencing a decline in 2019, are also being hit by rising costs that threaten to shrink profit margins and thus stock prices. Many companies have cited increased costs as a contributor to weaker earnings, including Harley-Davidson Inc. (HOG), Caterpillar Inc. (CAT), Church & Dwight Co., Inc. (CHD), Eastman Chemical Co. (EMN), Fortune Brands Home & Security Inc. (FBHS) and Ford Motor Co. (F). These large-cap companies attribute higher costs to factors including tariffs, increased commodity costs unrelated to tariffs, and an unfavorable exchange, per CNBC.
6 Blue Chips Facing Rising Costs
· Harley-Davidson Inc.; motorcycle manufacturer
· Caterpillar Inc.; construction machinery and equipment company
· Church & Dwight Co., Inc.; manufacturer of household products
· Eastman Chemical Co.; global specialty chemical company
· Fortune Brands Home & Security Inc.; manufacturer of home fixtures and hardware
· Ford Motor Co.; multinational automaker
While earnings estimates in 2019 have dropped off significantly to a modest 0.5%, revenue estimates remain roughly unchanged, at about 5.6%, per CNBC. This trend has puzzled market watchers. While margin erosion can be caused by various factors including currency fluctuations, higher rates and lower prices of goods and services, the likely culprit is a combination of higher costs and pricing pressure. After a period of expanding profit margins, to above 10% over the recent years, these new headwinds could reverse that trend, spelling bad news for earnings and thus stock prices of some of the most well-known blue chip companies.
Church & Dwight
A prime example of a large-cap company who has seen a bite taken out of its profit margins is Church & Dwight, the maker of Arm & Hammer baking soda. This week, the firm said that higher prices it has been charging for its products have not been enough to offset a rise in costs and falling margins. Church & Dwight highlighted an uptick in prices for commodities and transportation, as well as the impact of tariffs. Shares plunged 8% on the news. Nonetheless, Church & Dwight is hopeful it will be able to offset a rise in costs by boosting productivity and continuing to lift prices.
While it may seem logical to attribute earnings weakness to a difficult comparison to 2018, given last year’s boost from the Trump corporate tax cuts, some analysts have ruled out tax reform as the cause.
“Flat earnings growth in 19Q1 isn't due to tax reform,” said Refinitiv’s David Aurelio, per CNBC. "Based on what I can see; increased costs seem to be the driver."
Pricing pressure, another driver of margin erosion, has resulted from increased industry competition in markets such as semiconductors. Companies including Micron Technology Inc. (MU), Nvidia Corp. (NVDA), and Applied Materials Inc. (AMAT) have seen large drags on earnings thanks to headwinds including a down cycle in chip prices.
To rub salt in the wound, analyst on the Street have reduced their earning estimates for these sectors in the recent weeks, contributing to significant declines in Q1 estimates.
Has the Street Become Too Harsh?
Fears could be overblown, according to some market bulls.
“The trauma of December and the fear of a global slowdown have made analysts much more aggressive in cutting estimates,” said CFRA’s Lindsey Bell. "We don't appear to be going into a recession, and inflation is still sub-2 percent.”
Goldman Blames US-China Trade Wars
Last fall, analysts at Goldman called a reversal in expanding profits, citing the escalating U.S.-China trade war, per an earlier Investopedia story. The investment firm estimated that its 2019 EPS estimate for the S&P 500 would fall by 7% as a result of new tariffs, representing flat earnings growth over 2018.
In order to hedge against margin erosion and the threat of rising costs, analysts at Goldman recommend choosing stocks with “high and stable gross profit margins” as a way to battle this trend. In the firm’s US Weekly Kickstart report dated September, Goldman listed 33 stocks with ample pricing power to withstand rising input prices from tariffs, including Adobe Systems Inc. (ADBE), VMWare Inc. (VMW), Expedia Group Inc. (EXPE) and Autozone Inc. (AZO).