How high can prices go?

Red-hot inflation has forced some consumers to make tough choices but so far results season has left a slew of consumer goods giants looking in fairly fine fettle. The reason: big brand names are incredibly sticky. People put them in their shopping baskets without really thinking about the price, which is just as well as prices have been shooting up, something which has created tension between some supermarkets and manufacturers.

“Different types of consumer are reacting to the economy in a different way”

Kraft Heinz (KHC NYSE) which makes everything from beans to cream cheese recently stopped stocking Tesco (TSCO) after a row over price, although that’s now been resolved it raised interesting questions about the balance of power and the sustainability of price hikes.

Some Kraft Heinz lines have shot up by 12% in the last quarter and clearly that’s been enough to put some shoppers off because sales volumes have fallen – but only by 2.3%. Kraft CEO Carlos Abrams Riviera says that “different types of consumer are reacting to the economy in a different way” and looking at the latest data from the Office for National Statistics Opinions and Lifestyle survey he’s got a point. Some people say they are buying less (50%) but just as many people are buying exactly the same amount of food as they always have done (50%), they’re just noticing that they are paying more for it.

Kraft Heinz revenue growth and operating margins

Source: Company accounts/Stockopedia

The question Kraft Heinz and its competitors have to answer is, how much can they increase prices before demand falls to a point where profits can’t be maintained?

Significant headwinds

All have warned of “significant headwinds” during this earnings cycle, and all are considering the best ways to maintain margins whilst keeping customers. Kraft is making adjustments to the kind of products it sells, the size of those products and the packaging they are wrapped in.

“Consumers don’t expect manufacturers to swallow rising costs, but they do expect them to play fair.”

Reckitt Benckiser (RKT) is focusing on efficiencies and opportunities. It’s seen sales surge, thanks in part to a shortage of baby milk in the United States which has enabled it to grab market share. Even as that situation normalises it’s expecting to keep a good chunk of its new customer base who’ve been won over by the brand. And its core business has thrived despite passing on extra costs to its customers. Many of the items it produces are considered essentials and with memories of the pandemic still fresh nobody wants to cut back on cleaning products. Reckitt’s a trusted partner in many of our lives and that trust carries a premium. We feel safer using what’s familiar and because of that we are prepared to pay more, to a point.

Reckitt Benckiser revenue growth and operating margins

Source: Company accounts

But companies need to consider the narrative. Customers getting pay rises that get nowhere close to inflationary levels will take a dim view of brands adding to the pain in their wallets. Consumers don’t expect manufacturers to swallow rising costs, but they do expect them to play fair. Whilst shareholders will focus on the numbers, they also need to ponder the outlook.

Playing the long game

Bumper profits might not be such a boon if they precede a serious fall in sales; price rises need to be carefully considered and clearly explained. The demise of the 99p cheeseburger could take the shine off the golden arches but McDonalds (MCD NYSE) has played the price hike with a straight bat explaining directly to its customers that it had delayed, and minimised, price rises for as long as it could, and the fact it’s been unchanged for 14 years is a great hook. The value nature of its offer does provide a degree of insulation – an extra 20 pence isn’t going to break the bank – but all those 20ps add up.

“Pricing during these sensitive times is a dance; carefully choreographed and executed with perfect timing it can allow companies to continue to thrive.”

And it’s the ongoing nature of cost inflation that’s weighing on those consumer giants. Diageo (DGE) CEO Ivan Menezes fears a “potential weakening of consumer spending power” which could make the companies last lot of numbers harder to replicate. The drinks giant has benefited from a number of happy coincidences but that doesn’t detract from a sure-footed strategy which positioned it to take advantage of those shifts.

Diageo revenue growth and operating margins

Source: Company accounts

It’s spent money developing and marketing its premium spirits range, products which deliver much higher margins than craft beers and have become increasingly popular with younger drinkers. Whilst cutbacks are becoming a way of life “treats”, or “little luxuries” are right up there with those essentials and don’t forget even a discretionary item like a washing machine can become an “essential” if the home’s machine breaks down.

Pricing during these sensitive times is a dance; carefully choreographed and executed with perfect timing it can allow companies to continue to thrive. But one misstep and consumers will walk away, searching for another dance partner. There’s no blueprint for advisers or investors to follow as consumers are fickle and varied, but watching the way a company sells itself can give insight into how it’s going to be able to sell its products and at what price. And even if a company’s successfully passed on price hikes to date that’s no guarantee it will be able to do so again. Consumers will draw a line, and every line will be different.

Past performance is not a guide to future performance and some investments need to be held for the long term.