Commodity Prices: High and Volatile

Finance chiefs are contending with increasingly unpredictable prices for raw materials.

For Catherine D’Amico, CFO of Monro Muffler, relief from the uncertainty of commodity prices came in the form of tires — some $8 million worth.

The automotive-service company upped its total inventory by 11% between March and December of 2010, to $95.6 million. Two-thirds of that increase went toward tires to stay ahead of volatile commodity prices, a growing problem plaguing many CFOs these days.

Reluctant to pass cost increases to
still-frugal customers, finance chiefs have been exploring other ways to work around the price pressure they’re feeling from their suppliers. For D’Amico, that meant not only building up Monro’s tire and oil inventory but also pushing back on vendors for better pricing and visibility. (The company’s contracts require one-to-three-month warnings for pricing increases.) In turn, she can be confident in the information she relays to investors and can pass higher costs to customers only when absolutely necessary.

“It’s still a tight economy,” says D’Amico. “If we’re not competitive, people can go somewhere else, or they can defer [car repairs].”

Since last summer, coping with commodity prices has been anything but a smooth ride. Various raw materials have experienced price hikes, including oil, steel, wheat, and cotton (see chart). In February the Thomson Reuters/Jefferies CRB Index, which tracks the prices of 19 commodities, hit its highest level (344.47) since September 2008.

Commodity prices

Prices have been rising in large part because of the economic recovery. “Everyone knows when the economy begins to recover, you’re going to see an increase in commodity prices because demand is there,” says Chris Kuehl, economic analyst for the National Association of Credit Management. Making matters worse has been constricted supply, thanks to extreme weather conditions (drought in Russia and Ukraine, floods in Australia) and political turmoil (see the Middle East).

As a result, CFOs have to explain to investors why their earnings have become less predictable. “We see more and more businesses facing earnings volatility from raw-material price volatility,” said John Drzik, CEO of consulting firm Oliver Wyman Group, during a press conference last month.

Indeed, for some industries, dealing with volatile commodity costs has become the norm. Food companies have been carrying the burden of rising commodity prices for the past decade, according to General Mills CFO Don Mulligan. “Inflation will remain a central factor for our industry,” he says, predicting the average 4% to 5% cost inflation his sector has seen in recent years will continue this year as well.

The size of recent commodity-price jumps has thrown off forecasts at many companies. During a call with investors last month, Procter & Gamble CFO Jon Moeller said the impact of commodity costs on his business was double what the company expected at the beginning of the year, creating an “earnings headwind” of about $1 billion after tax (although the company has not adjusted its earnings-per-share guidance). The costs rose by about 20% compared with a year ago, he added. To compensate, P&G plans to raise prices on some products, substitute cheaper materials in others, and work on reducing its selling, general, and administrative costs.

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