Deflation has become a central concern these days.
The Federal Reserve sweats the notion of falling prices across
theeconomy , as it tends shrink asset values even as debts against
those assets remain constant. And companies hate
, because it usually signals weakening revenue, margins and
profits. For many firms, it's simply impossible to even think about
raising prices. But in a few industries, pricing power has come
back, and investors may be underestimating the futureearnings power
that can result.
Fewer planes means more pricing power
When the airlines experienced the turbulence of 2008, they took a
lot of planes out ofcommission . And as soon as theeconomy
rebounded and demand for air travel started to build, many assumed
that the airlines would simply bring all those mothballed planes
back on line. It hasn't happened. Instead, airlines saw this as an
opportunity to not shoot themselves in the foot, which they had
done every time before.
A quick glance at
Delta 's (
recent quarterly results spells out the benefits of restrained
capacity. The nation's largest carrier boosted the number of planes
in service by 2%, but demand was more robust than last summer,
helpingDelta to boost revenue per passenger from $12.22 per mile
flown to $14.22 -- a +16% jump.
The payoff: Analysts at Bank of America note that the
publicly-traded U.S.-based airlines likely earned a record $2.4
billion in the third quarter, up from a $260 million loss last
year. Industry laggard
even managed to post its first quarterly profit in two years thanks
to surging yields and slower-to-rise costs.
Industry watchers expect airline carriers to only slowly add more
planes back into the service, below the rate that would lead to
price wars. American Express just issued a report predicting that
tight supply will enable airfares to rise another +2% to +6% in the
United States next year, and +5% to +10% in the rest of the world.
That's a real positive forDelta , AMR and
United Continental (
, as these carriers are most heavily exposed to international
travel. The weak dollar may impede some Americans from traveling
abroad, but could trigger a fresh surge of foreign tourism to the
Fewer discounts mean higher prices
Auto makers are also benefiting from restrained supply to help firm
prices. Advertised prices for new cars and trucks are rising only
modestly, but auto makers are finally able to stop the rebate game,
which often took $1,000 to $2,000 off of the listed price. They can
afford to do that since many auto plants were shuttered during the
downturn, and few will be re-opened. Domestic auto plants are now
producing two million fewer cars than a few years ago, and similar
cutbacks have been made in Europe.
Even as industry sales still remain in a funk, pricing power is
already in evidence. Goldman Sachs expects U.S. auto and truck
sales to be around 11.5 million this year, well below the 17
million unit levels seen back in 2006 and 2007. Yet they expect
that figure to rebound to 13 million next year, 14 million in 2012
and 15 million in 2013. As long as the auto makers expand output at
levels in line or below industry sales, they should see continued
improvements in pricing power.
As an example,
Ford Motor (
has produced about -10% fewer vehicles in the third quarter than
the second quarter. That means fewer cars will pile up on dealers'
lots, and Ford will not need to resort to profit-sapping rebates to
move the metal. We're typically bombarded with year-end closeout
specials from car dealers in September and October, but that's not
happening as much this time around, as inventories remain quite
Reversing the freight pricing trend
When economic activity slowed, major publicly-traded trucking firms
such as Arkansas Best, Con-Way, J.B. Hunt, Knight Transportation,
and Heartland Express had to take a number of trucks out of
service. Nowadays, demand for freight carriers is increasing, and
thanks to better control of supply, these firms are finally able to
push through some badly-needed price increases. As Dahlman Rose's
Jason Seidl recently wrote, "the industry, whose recovery has
lagged that of other modes of transportation, is experiencing a
gradual return of pricing power, resulting from dwindling capacity
and improved demand."
As this is a business with high fixed costs, moderate revenue
growth can lead to much faster profit growth. For example,
J.B. Hunt (Nasdaq: JBHT)
is expected to boost sales +12% next year (half from volume
increases, half from price increases), though per share profits are
expected to rise +28%.
Arkansas Best (Nasdaq: ABFS)
is expected to swing from a $1.31 a share loss in 2010 to a $0.67
per share profit next year.
Sometimes, an industry giant can set the tone for a whole industry.
, one of the world's largest aluminum producers, has severely
reduced output, and management insists that the company will be
slow to rebuild output when the industry rebounds. It helps that
Chinese aluminum producers are cutting output. I discussed Alcoa's
newfound discipline in
this recent article
Alcoa's management discussed the improving industry dynamics in
great detail on its recent conference call. Other industry players
Century Aluminum (Nasdaq: CENX)
stand to benefit from Alcoa's leadership on the supply front. Then
again, that's bad news for companies like
Noranda Aluminum (
Kaiser Aluminum (Nasdaq: KASU)
, which count on cheap prices to boost their profit margins on
manufactured aluminum goods.
Action to Take -->
Many of these supply-induced pricing gains are impressive enough in
a weakeconomy . They'll look even more impressive when theeconomy
rebounds, as long as supply growth lags demand growth. These
sectors have already posted decent gains, but investors are likely
under-estimating their impressiveearnings power when theeconomy is
back in growth mode.
Of the companies mentioned here, Ford Motor, Aloca, AMR (because
it's much cheaper than the other airline stocks) and Arkansas Best
are my favorite names to consider.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.