The 'pricing power' trend of 2022 at risk from persistent inflation

Among the company results on Wednesday morning there was a very interesting theme running between a number of them, specifically those from the Spanish fashion retailer Inditex, the luxury watch and jewellery retailer Watches of Switzerland and the tour operator TUI.

All three appear to have had no difficulty in passing on price increases to customers.

Take Inditex. The world’s biggest fashion retailer, whose brands include Zara, Pull&Bear and Stradivarius, said that it has been raising prices by at least 5% since the spring as it grapples with rising costs.

Successfully passing on cost increases to consumers helped it raise sales by 19% during the first nine months of its financial year.

It meant that the Spanish company’s pre-tax profits during the nine months to the end of October came in at €4bn (£3.4bn) – up 25% on the same period last year.

Or, for another example, Watches of Switzerland.

Its sales during the 26 weeks to the end of October came in at £765m, an improvement of 31% on the same period a year ago, or one of 23% stripping out foreign exchange movements.

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Its pre-tax profits rose by 28%, to £83m, on the back of that.

Admittedly, that improvement also reflected openings of new showrooms, as the company likes to describe its outlets.

The UK’s biggest retailer of Rolex, Omega, TAG Heuer, Cartier and Breitling watches opened 20 showrooms across the UK, US and Europe during the period, taking the total to 188 worldwide, which clearly will have contributed to the increases in sales and earnings.

But the company, which also owns the famous Mappin & Webb jewellery brand, also made clear it had been able to increase prices.

Brian Duffy, the chief executive, noted that “growth [was] driven by increases in average selling price and volume”.

Now it is possible to argue that the kind of consumers who shop with Watches of Switzerland are sufficiently well-heeled not to worry about stumping up a few more pounds for the timepiece of their choice.

Bear in mind, though, that this is a company currently investing very heavily in its expansion. Its showroom costs were up by 36% on the same period last year. Yet its margin – once you strip out the one-off benefits of business rates relief in the same period a year ago – was more or less unchanged. Accordingly, then, it is at the very least passing on its higher costs to consumers.

The third example is TUI, the world’s biggest tour operator, which is back in the black following the reopening of international travel and which is expecting earnings to increase significantly in 2023.

The company, which is listed in London and Frankfurt, reported an underlying profit of €409m (£352m) for the year to the end of September. That compared with a loss of €2bn (£1.7bn) during the previous 12 months. Sales during the year almost quadrupled to €16.5bn (£14.2bn).

Sebastian Ebel, TUI’s chief executive, said winter bookings in the UK, its second largest market after Germany, were up 5% on pre-pandemic levels and, crucially, that average prices were up by 23%.

Those figures bear out something that tour operators have long argued, which is that even when household budgets come under pressure, people will still make going on their annual holiday a priority. It is something that has been borne out by bookings during recessions.

These are just three examples from today. They do, however, confirm a trend that has been seen more broadly around the world.

It was one of the major themes during the recent third quarter reporting season.

More than half of the companies in the pan-European STOXX 600 index recently publishing results for the three months to the end of September reported better than expected sales – and one of the main reasons for that was because they were able to pass on to consumers a higher proportion of the increased costs they have been experiencing than analysts had been expecting.

Nor has the phenomenon only been seen in consumer-facing businesses such as Watches of Switzerland, TUI and Inditex. It has also been seen in business-to-business companies as well.

DS Smith, the UK’s biggest paper recycler and one of Europe’s biggest suppliers of cardboard boxes, noted at its half year results last week that it had more than passed on higher costs to its customers.

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Adrian Marsh, the company’s chief financial officer, told analysts: “Price increases in the half more than offset significant cost increases of nearly £800m compared with last year alone.”

The ability to pass on at least all of the cost increases that a company is seeing to customers is known as ‘pricing power’ – where a business has a product, service or brand that customers simply cannot do without to such an extent that it can raise its prices without seeing a fall in demand for it.

It is something for which, in the kind of stock-pickers market that is expected in 2023, investors will be prepared to pay a premium.

As Nigel Bolton, co-chief investment officer of BlackRock Fundamental Equities, put it in a note this week: “We could see positive earnings next year, in our view.

“But company costs are also increased during periods of inflation, so we expect to see greater dispersion between the winners and losers – those companies that can generate cash and control costs versus those that can’t.”

Should high inflation persist into early 2023, as seems likely, this is a theme likely to prove recurring in the new year.

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