Posted by Davy Bui on June 18th, 2008 in Market Commentary

The post title is not my opinion, nor is it some economist’s view. It comes straight from the front lines but first some background.

Whirlpool Corp. (WHR) is the world’s largest appliance maker with operations all over the world. Specifically, they generate 57% of sales in North America, 20% sales in Europe, 20% sales in Latin America and 3% sales in Asia (all Q1 2008 numbers). While a little weak in the Far East, they’ve got a pretty good view of the current economic dynamics playing out across the globe.

Over the last few years and accelerating over the last year or so, the company is just getting slaughtered on material costs, which make up about 65% of their operating expense. The main components of material costs, in order of importance, are steel, oil & related products (plastics, resins, etc.), logistics (transport costs) and base metals. Here are their gross margins by region:

You’ll notice that the only region which saw margin erosion was North America. This table doesn’t tell the whole story, however, as Europe also saw eroding sales once you exclude currency effects so it’s probable that Europe’s margins are being held up mainly by foreign-exchange (FX).

The next time you hear some pundit blab on about moderate inflation or nonsense about CPI, PPI or “core” anything, keep the following blurb in mind (all quotes courtesy of SeekingAlpha):

Eric Bosshard [analyst]:

Right and then the third question is, understanding that it’s a global market for all of these commodities. I guess I don’t understand why the material cost impact is so significant and apparent in North America and it doesn’t appear
to have impact of the Latin American or European results.

Jeff Fettig [WHR CEO]:

Eric two things; one the year over deltas in the U.S. are by far more profound… In Europe again in euro terms although materials went up we were able to offset them with productivity improvement. So the weak dollar has had — we take about the impact of the weak dollar on an accounting point of view but if you look at it on an economic point of view, the U.S. is absolutely seeing more inflation by far than any part of the world due to currency. [emphasis added]

This conference call took place on 04/24/2008. Oil and other commodities have jumped substantially since then. Navigate the markets accordingly.

Whirlpool Q1 2008 Earnings Call Transcript on SeekingAlpha.com

As an aside, I am researching Whirlpool as a prospective investment and am still examining the company but my impression is the headwinds they are facing are significant. Their free cash flow number is malleable at this point and it is hard to have any confidence in management projections due to the volatile commodity environment as well as US economic conditions.