Disinflation is helping consumer companies, just not their customers

Retailers and restaurants are enjoying a bump up in gross margins as they finally get relief from rising prices for goods, services and labour.

From Dine Brands Global Inc. to Target Corp to Mattel Inc, Corporate America is benefiting from business costs that are now rising more slowly or actually retreating, underscoring the progress the Federal Reserve has made fighting inflation since kicking off its rate tightening cycle two years ago.

That cost relief isn't showing up at the cash register for consumers but is instead boosting company profits and helping fuel a boost in share buybacks.

The average gross margin for consumer discretionary and consumer staples companies in the Russell 3000 rose to 34% in the latest quarter, up from 31% four quarters prior. By comparison, the average gross margin for firms in the index — which encompasses about 98% of investable US equities — came in at 40%, slightly up from 39% four quarters prior.

Earnings per share for Russell 3000 companies are on track to reverse four straight quarters of year-on-year contraction by the end of March.

Mentions of "disinflation" and "deflation" on quarterly earnings calls by Russell 3000 companies are hovering around a seven-year high, according to a Bloomberg analysis.

Last month, Mattel Chief Financial Officer Anthony DiSilvestro said cost deflation was among the factors driving the toymaker's "significant increase" in fourth-quarter adjusted gross margin. Executives of Bath & Body Works Inc. and Autozone Inc cited decreased freight costs as aiding profitability.

Olive Garden owner Darden Restaurants Inc., which cut its 2024 same-store sales outlook on a pullback in spending by diners, and rival Dine Brands — parent of chains IHOP and Applebee's — attributed their latest quarterly margin gains to lower-than-expected commodity prices and stabilizing labour costs.

"Disinflation is the word of the quarter in retail. That's a good thing for the consumer," said Target chief operating officer and interim CFO Michael Fiddelke on a call this month. In February, Target rolled out an in-store discount brand aimed at budget-conscious shoppers.

But cost savings aren't always being passed on to diners and shoppers.

Bath & Body Works executives said they had raised prices on a number of products in 2023 and are confident they can still push through moderate price increases this year. Meanwhile, sandwich chain Potbelly Corp. is planning further hikes in its menu prices despite expecting more modest rises in raw materials prices and labour-cost stabilisation.

AutoZone CFO Jamere Jackson has ruled out lowering prices on abating cost pressures. "It gives us an opportunity to expand our margins," he said in an earnings call last month.

That extra cash is also finding its way into share buybacks, particularly for consumer-facing companies. Consumer discretionary and consumer staples firms in the S&P 500 increased spending on share buybacks in the fourth quarter by 53% and 80% respectively, outpacing the average 18% rise seen for the index, S&P Dow Jones Indices said.

The ability of companies to hold the line on prices, and even raise them, in the face of wavering consumer sentiment highlights the challenge monetary policymakers face stamping out the last, sticky remnants of inflation. Explaining the decision to hold off on a much anticipated rate cut last week, Fed Chair Jerome Powell said the further easing of price pressures this year would be a "sometimes bumpy path."

The moderation of business costs seen in recent months could also be shortlived, observed Mizuho Securities USA senior analyst John Baumgartner. "Labour is still reasonably tight and there's still a fair amount of bargaining power for employees," he said in a phone interview.

Shipping industry executives have warned that attacks on ships in the Red Sea region could continue to disrupt the global supply chain and nudge freight costs higher.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.