Import Price Inflation as a Silent Assassin

Includes: COST, TGT, WMT
by: Wall Street Strategies

By Brian Sozzi

The import/export price report from BLS is not known as a market mover on Wall Street. Let's face the facts: the report lacks the fanfare of the CPI, PPI and countless surveys that constantly update nationwide gasoline prices. Much in the same manner as Bruce Lee, however, the import/export price report is a silent assassin at the moment in the eyes of this old school movie buff. Investors should assign a greater degree of importance to the report given the secrets it tends to hold on the direction of future margins of global companies. Special attention is deserved right now as companies grapple with inflation for highly skilled domestic employees (shows up in operating expenses) and the raw materials used in the production process (shows up in cost of goods sold).

In March, import prices for all goods increased 2.7% year on year, the largest advance since June 2009. Fuel import prices skyrocketed 16%, some would argue from the Fed's monetary policy largesse and others from ascending living standards in emerging markets. The ugly truth regarding import prices is that an upward trend has been in place for the past six months. Increases on a year on year basis of 1% or more have occurred dating back to September 2010. Within the March report, food, feed and beverage prices rose 4.2%, the highest monthly gain since a 4.3% increase in July 1994. Every child's friend, veggies (+26.4%), were mostly responsible for the increase in the category.

Why should investors care? Well, due to a number of reasons, import inflation will find its way onto our dinner tables and backs in 2011. Many companies are seeking to adjust prices upward either through ticket increases or the reduction of yields on a bottle of detergent or box of cereal. The measures are paramount to recovering some percentage of the inflation attacking the business and meeting the financial expectations held by various shareholders.

Briefly, let's examine the happenings at three of the world's most prominent retailers, Target (NYSE:TGT), Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST). China is Target's largest source of goods. According to various reports, Wal-Mart obtains 75% of what it sells from China. Costco is filling its store pallets with inflationary products from the major consumer products vendors. The last time import prices rose dramatically was in February 2009, with increases trailing off by June 2009. Check out the effects on each of the aforementioned retailer's gross margins ...

  • Target: gross margin hit a peak in 1Q09 and then declined for three consecutive quarters.
  • Wal-Mart: gross margin hit a peak in the first quarter of calendar 2009 and went into a downtrend that ultimately ended in the fourth quarter of that year.
  • Costco: experienced a two quarter gross margin hit.

One of Bruce Lee's most famous quotes was "notice that the stiffest tree is most easily cracked, while the bamboo or willow survives by bending with the wind." As an investor, it's imperative to factor in many differing elements that may support or discredit an investment thesis on a stock. While not as sexy as other reports, in this day and age of global supply chains, import prices serve as a vital source from which to think about future earnings growth or risk to consensus forecasts.