How 5 companies are using pricing power to protect profits during high inflation

A select group of our Club holdings have recently demonstrated durable pricing power to protect profits during what continues to be a high inflation environment. Pricing power is a company’s ability to raise prices on products and services without impacting demand. That’s not an easy task. For companies, elevated inflation means higher input costs — higher costs on the goods and services required to run their businesses. In turn, they want to raise prices and put that burden on their consumers and clients. However, such moves have to be done delicately because consumers and clients are also feeling the pinch of inflation and don’t want to pay more. The rate of inflation has, indeed, cooled over the past year in the U.S. from multidecade highs, but it remains well above historical averages. The Federal Reserve has tightened monetary policy through aggressive interest rate hikes to bring inflation closer to its 2% target. The Fed is walking a tightrope — looking to crush inflation while trying to make sure the economy doesn’t dip into a recession. In a recent note, UBS acknowledged, “Inflation may trend back toward the Fed’s target sooner than expected reducing the relative advantage of companies with pricing power.” However, the analysts pointed out that prices for now do remain elevated, making companies with pricing power “relatively better-positioned to maintain the price hikes implemented in prior quarters.” In fact, UBS believes that “companies with pricing power have the potential to outperform the broader market in the months ahead.” We’ve spoken to this dynamic before, noting that while inflation may be coming down — and with it input costs — the price hikes previously passed through are more likely to sustain. Typically, the more valuable or essential a product is, the more leverage a company has to increase prices. Pricing power can help boost revenue and lead to higher profit margins. However, it needs to be executed effectively so customers don’t trade down to cheaper products or do without. That’s why we’re focusing on companies in our portfolio such as Caterpillar (CAT), Procter & Gamble (PG), Linde (LIN), Microsoft (MSFT), and Salesforce (CRM). They’re all leaders in their industries with great management teams who have been through business cycle after business cycle. CAT YTD mountain Caterpillar YTD performance Caterpillar , the world’s leading manufacturer of construction and mining equipment, has historically used price increases to stay ahead of inflated input costs, resulting in a boost to revenue and margin expansion. Second quarter operating profit increased by 88% to $3.65 billion. On the post-earnings call, Caterpillar CFO Andrew Bonfield said: “Year-over-year favorable price realization and higher sales volume were partially offset by higher manufacturing costs which largely reflected higher material costs.” Sales were higher across its three primary segments including Construction Industries, Resource Industries, and Energy and Transportation — all of which had what management calls “favorable price realization.” On the call, Caterpillar CEO Jim Umpleby said: “We saw significant increases in price in the second half of last year. And that will lap in the second half of 2023. But we still expect to benefit from positive price in the second half, but it will moderate and certainly understandable based on that, again, those strong price increases in the second half of last year. And as always, we’ll continue to monitor the global price environment. We’ll determine if actions need to be taken.” PG YTD mountain Procter & Gamble YTD performance Procter & Gamble , the maker of Gillette and other daily-use household products, has been effectively using pricing power across its product portfolio. “Pricing has been a positive contributor to our top-line growth for something like 48 out of 51 for the last quarters,” said Jon Moeller, CEO of Procter & Gamble, during the company’s recent fiscal fourth-quarter earnings call. While management has seen some trade down to private label brands, P & G has been able to hike prices across value tiers with overall minimal customer pushback. In the company’s most recent fiscal year , organic sales increased 7% — driven by a 9% increase from higher prices and a 1% boost from a favorable product mix but partially offset by a 3% decrease in shipment volumes. That’s how you know there’s real pricing power when the impact of higher prices on top-line growth more than offsets any volume declines. Prices were up in fiscal 2023 in all of the company’s operating segments: Beauty, Grooming, Health Care, Fabric & Home Care, and Baby, Feminine & Family Care. P & G’s pricing power is linked to its innovation strategy, which consists of continuous brand building and product development to create more value for its retail partners and more importantly for customers who are attracted to better-performing products. Investment in innovation solidifies its strength among industry competitors, which helps grow market share. LIN YTD mountain Linde YTD performance Industrial gas giant Linde has a strong track record of passing pricing through to its customers, mainly through contractual agreements. Linde serves customers in more than 100 countries where pricing trends vary greatly. “Pricing is incredibly local,” as the company puts it, making it necessary for the company to protect against input cost spikes and be accepted by customers who rely on the products and services Linde provides. During the company’s fiscal second-quarter earnings call, Linde CFO Matthew White said, “Higher prices are the main driver of underlying sales growth.” Linde’s sales for the quarter increased 6% year-over-year driven by a 7% increase in price. Higher pricing also helped with margin expansion. On a companywide basis, quarterly margins excluding cost-pass-through increased 350 basis points year-over-year and 50 basis points sequentially. This helped it deliver a 24.9% after-tax return on capital, which was a new record high. Management acknowledged that disinflation in developed markets could impact pricing strength. Still, White said he expects overall pricing to remain in line with overall inflation, adding he thinks inflation will “continue to be higher than what we have seen at least in the past 10 years.” White also reminded analysts on the call that many countries are still seeing double-digit inflation. MSFT YTD mountain Microsoft YTD performance In a big step to monetize its artificial intelligence efforts, Microsoft came out of the gate with a hefty $30 per month additional charge for a new AI subscription service for its Microsoft 365 programs. Adding the Copilot feature, announced in July, could increase monthly prices for enterprise customers by as much as 83% . Also last month, Microsoft alerted some international customers that it’s following through on previously announced price hikes in Australia, Canada and New Zealand. Microsoft’s pricing power comes down to the simple fact that they have positioned themselves as a core backbone of global productivity. There isn’t much choice other than to pay up. In the case of Microsoft, few companies, if any, can provide such a robust enterprise ecosystem that covers everything from the operating system of a worker’s personal computer to the cloud environment storing and analyzing the company’s data and workloads. It’s for this reason we see the stock pop whenever pricing moves are announced. CRM YTD mountain Salesforce YTD performance Last month, Salesforce announced price increases for the first time in seven years. Customers using services including Sales Cloud, Services Cloud, Marketing Cloud, Industries and Tableau will go up by an average of 9% for new customers and existing customers purchasing new cloud products in August. The company has been working to find ways to boost top-line growth and increase operating margins while getting costs down. So, this move could help on those key fronts. As we wrote previously when the company first announced the price hikes, it’s expected that Salesforce customers will pay up with minimal pushback since the company added thousands of new features including artificial intelligence innovations to help with productivity. We should see the pricing benefit come through the company’s financial results in the next fiscal year. (Jim Cramer’s Charitable Trust is long CAT, PG, LIN, MSFT, CRM. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

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