From the June 2011 issue of Treasury & Risk magazine

In the Shadow of Inflation

Bracing for higher costs and interest rate hikes means rethinking just-in-time inventories, renewing cost-cutting and ramping up hedging strategies.

Ross Stores saw “pack-away” goods—those it buys and warehouses for six or more months—increase to 47% of consolidated inventories in February from 33% a year earlier. The company, which operates two off-price retail chains, also shaved its in-store inventories to run its business more efficiently. Both strategies will prove advantageous if inflation picks up, which seems likely given rising commodity prices and higher interest rates as governments seek to pay down enormous public debt. Hawaiian Airlines, which survived the 2008 spike in fuel prices, has also instituted a variety of policies to mitigate inflation.

Peter Ingram, CFO and treasurer of the Honolulu-based airline since 2005, says the company has implemented both operational and financial hedging strategies to smooth volatile fuel costs.

More ominously, Ross’s pack-away success probably reflects the inflationary challenges already faced by other companies. Chaville notes that Ross buys mostly closeouts stemming from supply-chain disruptions and says such opportunities tend to increase as production costs rise. A vendor’s customers may shrink the size of their orders or cancel them altogether—a setback for the vendor but a boon for Ross.

“We found some terrific product—great brand names—that we thought would resonate with customers,” Chaville says about the pack-away increase.

Some of Hawaiian Airlines’ competitors, such as Aloha Airlines and ATA Airlines, succumbed to surging fuel prices in 2008. Hawaiian filled the market void they left, which helped increase  revenues and offset its own soaring costs. That 2008 experience also prompted a series of cost-cutting measures that should help it weather today’s rising costs.

For example, the airline began a project a year ago to centralize procurement, eliminating redundancies caused by the operating units acting as silos. The company can now use its human resources—its second biggest expense item—more efficiently while focusing resources to procure supplies more cost-effectively.

On the liability side, interest rates remain historically low, giving companies the opportunity to shift into low-cost, fixed-rate debt—whether by refinancing or using interest-rate swaps—to carry them through an inflationary period. FMC, for example, issued $300 million in 10-year notes in 2009, after the financial markets regained their equilibrium.

“We didn’t need all of the money at the time,” says Thomas Deas, corporate treasurer at the Philadelphia-based chemical manufacturer. “But our analysis showed that interest rates for the 10-year, even today, have been higher 95% of the time over the last 49 years.”

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