Dealing with inflation
One of the biggest questions investors currently face is how to deal with the prospect of inflation. Analyzing how rising prices will impact a company's potential is challenging.
There is no right or wrong answer to this question. Some companies will be able to deal with higher prices exceptionally well. Other companies will struggle to pass higher prices on to consumers. Some companies will be able to absorb costs into their profit margins without passing these costs onto consumers.
Being able to pass on higher costs to consumers without issue is a very favorable position for businesses to be in, but there are not many companies that can do this. The ability to absorb rising costs into profit margins can keep the doors open, even if it's not good for growth. Neither of these scenarios is the best long-term strategy.
Companies can also try and offset rising prices by reducing costs or improving efficiency. Over the past couple of decades, there has been a significant reduction in the cost of technology, allowing companies to navigate rising prices and other areas. This is another example of how businesses can offset rising price pressures. They can invest in new or cheaper technology to help streamline operations and push down costs, absorbing rising prices.
Put simply, how inflation will impact a business will differ from company to company. There is no set formula investors can use to try and analyze the impact of higher prices on individual businesses.
Inflation is not a bad thing for all companies. There are different types of inflation for different types of businesses. In the service sector, retailers and the restaurant industry are having to deal with higher wages, food and materials costs. Still, they are also benefiting from wage inflation in their customer base.
The Chipotle standard
Chipotle Mexican Grill (CMG, Financial) is a great example of this trend in action. According to the company's results for its fourth quarter and fiscal year ended Dec. 31, 2021, the company is having to pay more for its ingredients and workers. However, it seems as if the company's consumers are more than happy to pay higher prices to cover the costs.
Figures suggest the company has increased its prices by around 6% over the past 12 months, and it is planning further price hikes. In the fourth quarter, the company's overall operating margin was 8.1%, up from 7.3%. Total revenues increased 22%, and comparable restaurant sales increased 15.2%.
The corporation is expecting to report restaurant sales growth in the mid to high single digits for the first quarter of the year, and it is planning to open as many as 250 new restaurants in 2022.
It is notable that the corporation increased its minimum wage from $13 an hour to $15 an hour last year. This implies higher wages are not necessarily a bad thing for a company. Not only has the company been able to raise prices to more than offset this increase, but higher wages in general means that people have more purchasing power and won't need to sacrifice things like fast food in order to keep their bills paid.
Nothing to fear
Chipotle shows that companies with a devoted customer base and reliable brand do not really have much to fear from inflationary pressures. The company has been able to increase prices, and sales are still growing.
Some of this will be down to consumers' association with the brand, and some will be due to wage growth elsewhere in the economy. An increase in pay from $13 to $15 per hour is an increase of 15%, which is more than double the 6% increase in menu prices the restaurant group pushed through in 2021. Similar rates of wage growth across the rest of the economy could help many businesses navigate the current inflationary pressures causing so much angst among the investment community.
