“The state is that great fiction by which everyone tries to live at the expense of everyone else.” ― Frédéric Bastiat
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This article is part of our 'other voices' on the Maven and comes from Tony Daltorio, growth stock expert and Investors Alley colleague.
While Wall Street fawns over earnings reports from market darlings such as Apple (AAPL), something else caught my eye this earnings season. That is the fact that the multi-front trade battles are prompting warnings from some of the largest U.S. companies that higher tariffs will squeeze their profit margins, force them to pass on the pain to suppliers and push prices up for consumers.
A look at corporate executives’ comments since the start of the second quarter reporting season show a marked change from the prior quarter. In the first quarter, attention focused on calculating the benefits to companies’ bottom lines of the corporate tax cuts Congress passed at the end of 2017. But now the focus has shifted to the trade war and rising costs.
According to Bespoke Investment Research, about halfway through earnings season, the percentage of conference calls where tariffs have been brought up have more than doubled relative to the first quarter – 39.8% vs 16.6%. For the entire first quarter earnings season, the word tariff only came up 290 times, but has already cropped up over 600 times, says Bespoke.
I liken it to a three-act play. In the first act, companies were caught off guard by rising costs and their profits were hurt, negatively affecting their stock. In the second act, companies got a handle on the cost environment, announcing their intentions to pass on higher costs to consumers. Wall Street has gotten confident in that story, and stocks in sectors including consumer staples are in the process of recovering. But it is the third act that has yet to unfold and is worrisome. What happens when all of these pricing increases hit the economy?
Company Executives’ Caution
The AutoNation CEO, Mike Jackson, said in his earnings call that so far, auto manufacturers have absorbed increases in the price of steel and aluminum without passing them on as they await the outcome of trade negotiations. But if tariffs becomes a permanent state of affairs, then manufacturers will have no choice but to try to pass those higher costs on. He said: “Consumers will not pay those higher prices. Volumes will fall, and they’ll have a material impact on the industry and on the economy.”
To date, GeneralMotors (GM) has seen a $2 billion rise in its costs from higher commodities prices as well as currency headwinds. The company had been on track for another year of record profits until steel and aluminum tariffs were imposed. Even though GM sources most of metals needs domestically, it was hit hard because U.S. producers raised their prices by 40% to 50%, or much more than the tariffs themselves.
And there are many other companies that have sounded a note of caution too. . . . .
Caterpillar (CAT), for example, a big purchaser of steel to build its construction equipment, said it’s preparing for as much as $200 million in tariff-related costs in the second half. Industrial companies from Danaher to United Technologies said they were eyeing price increases because of their rising costs.
And for consumers, price increases will leave a bad taste: Coca-Cola said it will charge more for soda to offset the rising cost of the aluminum it buys for its cans. “I think it’s going to be one of those things that goes through into consumer pricing,” cautioned James Quincey, CEO of Coke, after the company increased prices in response to increases in an array of costs, from freight to the aforementioned aluminum used in Coke cans.
The protectionist measures threaten tech companies too. And it’s not just semiconductor companies and their supply chains that are being affected.
One prominent company that is sounding a warning about tariffs is Apple. In its latest filing with the SEC, Apple said tariffs and other protectionist measures may “adversely affect” the company. Here is exactly what Apple said in the filing:
“International trade disputes could result in tariffs and other protectionist measures that could adversely affect the Company’s business. Tariffs could increase the cost of the Company’s products and the components and raw materials that go into making them. These increased costs could adversely impact the gross margin that the Company earns on sales of its products. Tariffs could also make the Company’s products more expensive for customers, which could make the Company’s products less competitive and reduce consumer demand. Countries may also adopt other protectionist measures that could limit the Company’s ability to offer its products and services. Political uncertainty surrounding international trade disputes and protectionist measures could also have a negative effect on consumer confidence and spending, which could adversely affect the Company’s business.”
And indeed, Apple’s fastest-growing division, which includes Apple Watch, AirPods earphones and HomePod speaker, is at risk of being caught up in President Trump’s latest proposals to slap a 25% tariff on Chinese imports. The devices that make up the bulk of Apple’s multibillion-dollar “other products” unit are highly exposed to the looming trade war. Apple will be forced to raise prices to compensate for the higher duties on the Chinese-made products or take a hit to its profit margins.
This “other products” is very important to Apple’s future since it is on track to become the company’s third-largest revenue source shortly, trailing only iPhones and services. Apple shipped about 3.5 million watches in the second quarter, up 30% year on year, with more than half of those sold in North America. And its “other products” revenues rose 38% in the quarter, compared with iPhone revenue growth of 17% year on year.
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