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Corporate America braces for commodity crunch

By Ben Rooney, staff reporter


NEW YORK (CNNMoney) -- Wall Street has been riding a wave of strong corporate profits for months, but surging commodities prices are making some investors nervous about earnings growth in the second half of the year.

Bad weather in many parts of the world has damaged crops and led to a run on agricultural commodities, such as wheat, cocoa and sugar. And industrial commodities, such as copper, have rallied as demand for raw materials has grown, particularly in emerging economies.

Higher prices are a boon for companies such as Exxon Mobil (XOM, Fortune 500), Alcoa (AA, Fortune 500) and Caterpillar (CAT, Fortune 500), which make money by extracting, refining and selling commodities. But for more consumer-driven companies, the amount of money spent on these raw materials could soon be cutting into their profit margins.

Procter & Gamble (PG, Fortune 500) and Colgate-Palmolive (CL, Fortune 500) both recently said profit margins have already narrowed, even as they reported strong fourth-quarter earnings. Hershey's (HSY, Fortune 500), which is being hamstrung by high prices for cocoa and sugar, just lowered its earnings outlook for 2011.

Also this week, cereal maker Kellogg (K, Fortune 500) said that it has "implemented selective price increases to reflect higher input costs."

The rise in raw commodities hasn't cut into companies' bottom lines yet and some analysts think they will continue to be able to absorb them.

"The top-line momentum has more than offset rising input costs," said Alec Young, an equity strategist at Standard & Poor's. "It all depends on how high prices go, but it seems premature to sell stocks on this issue now."

Other investors believe the worry about commodities prices is entirely overblown.

"It's not that you ignore them, but you don't blow them out of proportion," said Bob Brusca, economist at FAO Economics.

Brusca argues that commodities are a small part of the overall production cost for most companies, while labor costs, typically the largest, are relatively cheap. And companies continue to benefit from high levels of worker productivity.

"Labor has really been a source of profitability for most companies," said Brusca.

But companies may not be able to rely on cheap labor to boost profits for much longer, said Burt White, chief investment officer with LPL Financial in Boston

"As employment begins to take hold and unemployment declines, margins will compress and earnings will fall," he said. "This is only partially baked in."

White believes that investors are overly optimistic about earnings, and that the threat posed by rising commodity prices is "under-appreciated."

As commodities prices rise, he said, companies will be forced "to either raise prices in a fragile recovery or take a hit to profits."

"The latter is going to be the trend going forward," said White. "Companies just can't pass on price increases of raw materials to consumers." To top of page

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