Wage gains threaten to squeeze retail, industrial profits
Higher labour costs pose risk to U.S. firms facing trade tensions, limited pricing power
Rising wages are beginning to eat into the profits of some U.S. companies.
Businesses from dollar stores to hotel operators to fast-food chains have warned in recent months that higher labour costs have been a drag on their profits — a potential headwind for the nine-year stock-market rally as it struggles for momentum ahead of the second-quarter earnings season.
Average hourly earnings increased 2.7% in June from a year earlier, according to the Labor Department’s monthly jobs data released Friday. Although that is below the 2.8% economists expected, wages have risen at least 2.5% for 16 of the past17 months, a faster pace than recorded earlier in the economic expansion.
That is good news for U.S. workers who have seen tepid wage increases over the past few years and may benefit some businesses as consumers become more willing to open their wallets for discretionary purchases.
But the higher costs pose a threat to some U.S. companies that are already facing traderelated tensions and a limited ability to raise prices to keep up with inflation. Fears about rising wages sparked concerns back in February and sent stocks tumbling as investors worried the tightening labour market may finally trigger higher inflation. Economists at Goldman Sachs predict that every percentage-point increase in labor-cost inflation will drag down earnings of companies in the S&P 500 by 0.8%. In total, the bank estimates labour costs equate to 13% of revenue for companies in the S&P 500.
“At the end of the day, I haven’t heard this many CEOs talk about shortages in skilled labour and wage increases to attract talent in a long time — in at least a decade,” said Will Muggia, president and chief executive at Westfield Capital Management in Boston.
According to a report from Bank of America Merrill Lynch Global Research,10% of companies in the S&P 500 mentioned higher labour costs as a factor that weighed on their firstquarter results, up from 8% in the fourth quarter and the high- est level since the bank began tracking the data in late 2015.
The earnings of companies in the industrials sector, which has already been hit hard this year by trade tensions and rising expenses for things such as raw materials, are most susceptible to increasing labour costs, followed by the consumer-discretionary sector, Goldman says.
Labor costs equal 21% of revenue for companies in the industrials sector, and analysts expect that a percentage-point increase in labor-cost inflation would dent the sector’s earnings by 1.5%.
Some industrial companies are already struggling to find workers, a sign that they may be forced to raise wages. In its first-quarter earnings call, railroad company Union Pacific Corp. said it was offering bonuses in more competitive labour markets. In addition, building-products companies Allegion PLC, Fortune Brands Home & Security Inc. and A.O. Smith Corp. all mentioned labour shortages as well.
In a traditional economic cy- cle, companies would attempt to pass along the increasing cost of labour to customers, but that doesn’t appear to be happening this time.
A National Association for Business Economics survey for the first quarter showed 56% of respondents reported rising wage costs — the highest share since the survey’s inception in 1982 — but just over a quarter of respondents reported charging customers higher prices.
That discrepancy is partly because of the pricing power of Amazon.com Inc., which has disrupted industries from retail to entertainment to health care with its low prices and free shipping options.
“Some tech companies are threatening to get into every industry now,” said Matt Miskin, market strategist for John Hancock Investments. “That’s kind of a major headwind to the traditional wage growth dynamic that we’ve seen in past cycles.”
Competition with online retail will make it particularly difficult for retail companies to offset wages that are rising much faster than in other industries.
In the three months through June, non-supervisor retail wages were up 3.9% from a year earlier, based on a three-month average, their strongest growth since 2002, according to the Labor Department.
According to Goldman, a percentage-point increase in wage inflation would reduce earnings in the consumer-discretionary sector by 1.1%. And Bank of America notes that operating margins have begun to soften in the sector — which houses the most labour intensive companies in the market.
Discount-store operators Dollar General Corp. and Dollar Tree Corp. are among the re- tailers that pointed to higher labour costs in the first quarter when their earnings fell short of estimates. “Increased competition, looking at retail, prevents certain brick-and-mortar retailers from boosting wages because that makes them even more uncompetitive to the Amazons of the world,” said Mike Dowdall, investment strategist for BMO Global Asset Management.
Meanwhile, companies in the leisure industry, many of which sit in the S&P 500’s consumerdiscretionary sector, are the most exposed to increases in the minimum wage, Goldman says. Hotel operator Marriott International Inc. cited a tightening labour market and rising wages in its first-quarter earnings call as it reported declining profit margins in North America.
“When we look at cities across the country, there aren’t any places where wages, labour costs are growing at 2%,” Marriott Chief Executive Arne Sorenson said at a Goldman conference in early June. “They’re growing at faster rates.”
“When we look at cities across the country, there aren’t any places where wages … are growing at 2%. They’re growing at faster rates.” ARNE SORENSON MARRIOTT CHIEF EXECUTIVE