Higher inflation rates likely to take a toll on third-quarter earnings

Israel's consumer prices rose the most since 2002, jumping 2.5 percent during June, July and August.

October 18, 2007 20:36
3 minute read.
Higher inflation rates likely to take a toll on third-quarter earnings

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Rising inflation is beginning to show in Israel's businesses with at least four of the country's largest companies to warn over the past week they expect to post substantial increases in financing expenses over the third quarter, with costs estimated to rise by tens of millions of shekels. "This is happening because these companies have bonds and a lot of debt linked to the Consumer Price Index. Once the CPI increased in size like it did over the third quarter, it pushed the amount of interest that the companies have to pay even higher," said one local analyst. Israel's consumer prices rose the most since 2002, jumping 2.5 percent during June, July and August, the three-month period upon which Israeli accounting laws require companies to base third-quarter earnings. Included among companies who say they will be hurt by rising consumer prices are Africa Israel, which has seen its profit surge in the past year as property values increased, and last week forecast a "significant" increase in third-quarter financial costs because of higher inflation. Meanwhile, Housing & Construction said financial expenses may increase by about NIS 75 million; Strauss Group said third quarter financing costs may rise by NIS 20m.; and most recently on Thursday Migdal Insurance Holdings, the country's biggest life insurer, said it probably would report a third-quarter loss after inflation rose, returns on its investments fell and the dollar weakened. "The 2.5% rise in the CPI over the reporting period will cut into fee revenue," Migdal said in a report to the Tel Aviv Stock Exchange. IBI said Thursday that Delek Group and IDB Holding may report declines in third-quarter profits after third quarter inflation raises financial costs, while real-estate developers such as Jerusalem Economy and Property & Building also may be affected by rising prices. "These companies have a lot of debt and bonds linked to the consumer price index and will have an unusual amount of financial expenses," said Yuval Zehira, the head of research at IBI. "This may be the first quarter in a while in which earnings will not send shares higher." The CPI is an index number measuring the average price of consumer goods and services purchased by households and the percent change in the CPI is a measure of inflation. It can be used to adjust wages, salaries, pensions, or regulated or contracted prices for the effects of inflation. The Bank of Israel is mandated by law to keep inflationary rates in a 1-3%, a target range that the government believes is the optimum number to generate the most economic growth. "Too much inflation is a bad thing as it weakens the local currency, while deflation is not good because then prices don't rise and companies have no power to increase prices," one analyst told The Jerusalem Post. In order to ensure that the inflation rate falls within the target, the Central Bank either lowers, raises or keeps unchanged its benchmark lending rate each month. Last month, the Bank of Israel kept its benchmark lending rate unchanged for October, after raising it the previous two months, saying the strengthening shekel has eased pressure on inflation. In September the CPI dropped 0.5% after the shekel appreciated as much as 8% against the dollar since August 1, cutting the cost of imports and housing, which are traditionally linked to the US currency, while putting a brake to inflation. According to a Bank of Israel survey of economists released Wednesday, expectations for inflation during the next 12 months have declined to 1.5% from as much as 2.7% in July. Last year the Central Bank considerably missed its target rate, when inflation ran at minus 0.1%. Despite the biggest quarterly CPI increase in five years, analysts don't expect a long-term impact on companies faced with increasing costs. "These are technical, rather than real losses," said Shlomo Maoz, chief economist at Excellence Nessuah. "This will reverse itself over the fourth quarter and we have already seen a drop in the CPI in September of 0.5% and I expect in October we will see a decrease of 0.1%." Bloomberg contributed to this report.

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