Three energy companies, a fertilizer firm and a drug maker have all been doing super well while most of the rest of the U.S. grapples with soaring prices.
There’s a silver lining to the worst inflation since the 1980s. Just ask the companies that are making bank on higher prices.
Hiking prices gets easier during inflation, when everyone seems to be doing it. Sometimes charging more makes sense. Inflation raises the cost of production, and most companies pass on the cost to customers. Sometimes, however, the higher prices go above and beyond the extra expenses companies incur.
So Forbes has been keeping track of the companies that have expanded their operating margins, a measure that narrowly gauges how much money companies make from selling their products, to see who is piling up the profits.
Operating margin is a fair indicator because it excludes borrowing, Wayne State University finance professor Mai Iskandar-Datta told Forbes. “Essentially, you’re trying to have a broader picture of company performance,” she said. “You’re trying to see how they’re doing without considering financing. It separates financing and investment decision-making.”
Keep in mind how tough inflation is on employees. Worker pay isn’t keeping up with higher prices. According to the U.S. Bureau of Labor Statistics, real average hourly earnings – wage growth minus inflation – has dropped by 2.8% over the last year. Add in the fact that people are working fewer hours, and the story gets even grimmer. Real average weekly earnings have plunged by 3.7% over the same time period. As the third-quarter earnings season comes to an end, it may come as no surprise that three of the top five spots on the current list of widest operating margins are energy companies.
The operating margin for natural gas company EQT Corp. surged from 20.3% for the 12 months ending in September 2021 to 64% over the last year. The 64% is more than 20 percentage points greater than the company’s prior all-time high, set in 2015. EQT didn’t respond to a request for comment. Just as a point of comparison, and acknowledging the retail industry is a slightly different animal, big-box store chain Target announced Wednesday that its operating margin fell to 3.9% in the third quarter from 7.8% in the same period a year ago.
How They Did It:
A new addition to the S&P 500 Index, EQT is the largest producer of natural gas in the U.S. As the price of natural gas spiked in the wake of Russia’s unprovoked invasion of Ukraine, so did EQT’s revenue. On its earnings call and in an October 26 investor presentation, the company cited cost reductions at its West Virginia wells and the impact of acquisitions as reasons it’s piling up the cash.
But there’s something else to consider when examining the profit margins of EQT and other energy companies. They aren’t investing as much in new projects as they normally would during the boom stage of the commodity cycle. Research and development and exploration expenses take a bite out of operating margins. So if energy companies aren’t shelling out for new wells, operating margins will be higher.
“Today, we’re seeing capital restraint across the sector,” Gabriele Sorbara, a managing director at Siebert Williams Shank & Co., told Forbes. “If they’re growing, it’s mostly low- to mid-single-digit oil-production growth. There’s a tremendous amount of internally generated free cash flow and cash on balance sheets. After many years of poor returns from the (explorers and producers) with extreme boom-and-bust periods, companies are now maintaining discipline and returning cash to shareholders rather than deploying capital to growth.”
Marathon Oil, the exploration and production company that traces its roots to John D. Rockefeller’s Standard Oil, posted a 46% operating margin over the last 12 months. That was a 32% gain from the prior period and set a new high watermark for the company. Marathon didn’t respond to a request for comment.
How They Did It:
There’s no surprise here, but higher oil prices are great for producers’ bottom lines. “A lot of it is pricing-related with Marathon’s realized oil price roughly $24 per barrel higher and natural gas nearly 88% higher than a year ago,” Sorbara told Forbes.
After its most recent quarterly report, fertilizer giant CF Industries cracked the top five. The Deerfield, Illinois-based company grew its operating margin by 28% over the last year. The 49% operating margin over the last 12 months is just shy of the 52% it posted in 2012. CF Industries didn’t respond to a request for comment.
How They Did It:
“It’s pretty basic,” Charles Neivert, a senior research analyst at Piper Sandler, told Forbes. “In particular, where things went really weird was when the Ukraine situation started getting crazy. At that moment, some things were already in place that were leading to higher fertilizer prices, but the war just exacerbated it.”
The rising cost of grain prior to the outbreak of the conflict set the stage for higher fertilizer prices, according to Neivert. “This is a food issue,” he said. “Higher grain prices lead to higher fertilizer prices.” CF benefitted the most among its peers because it focuses primarily on the production of nitrogen fertilizers. “The one fertilizer that’s not all a choice is nitrogen,” Neivert said. “You can play games with potash and phosphate, but it’s a virtual lock that if you don’t put down nitrogen on a crop like corn you will virtually guarantee yourself a drop in yield.”
Add another energy company to the list: Occidental Petroleum’s operating margin skyrocketed from 11% a year ago to 37% for the 12 months ending in September. Still, Occidental has done far better in the past. In 2008, it reported 12-month operating margins of just over 50%. Occidental didn’t respond to a request for comment.
How They Did It:
Like their competitors on this list, higher energy prices are a boon for Occidental. What will Occidental do with the profits it did make? “As we enter 2023, we expect that our free-cash-flow allocation will shift significantly toward shareholder returns,” CEO Vicki Hollub said on the company’s third-quarter earnings call with investors and analysts.
Biogen, the pharmaceutical company that’s made its name treating multiple sclerosis, saw its operating margin jump from 3.4% for the 12 months ending in September 2021 to 22.2% for the most recently completed 12 months. Biogen declined to comment.
How They Did It:
Call it a comeback. Biogen’s margins plummeted throughout 2021. It was just eking out a profit last year, according to FactSet data. While sizable, the pharmaceutical giant’s operating margin is about half of what it was before the pandemic. “In 2021, there’s a bunch of things that happened on a GAAP basis,” Myles Minter, a research analyst at William Blair, told Forbes. “They were going through a major drug launch for Alzheimer’s disease. They were building inventory and a salesforce to back that up. It was an absolute flop of a launch.” Minter added that Biogen’s increasing margins are the result of cutting spending rather than bringing in more money. “They can’t price gouge because they have generic competition,” said Minter.
We’re looking at rolling 12-month changes in operating margins for S&P 500 members. Using FactSet, we gathered the profit margins for the most recently reported year for companies with data as of September 2022.
We then compared that to the 12 months ending at this same time in 2021.
Our focus is on those companies that sell products we all buy. Therefore, banks and other financial firms were excluded from our calculations, while companies in sectors like oil and gas, retail and pharmaceuticals remained.
We also eliminated companies that weren’t profitable in 2021 and 2022. So, for example, cruise operators and much of the airline industry were ruled out.
One more thing: We’ve solely relied on values following generally accepted accounting principles (GAAP).
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