Corporate profitability has more or less returned to pre-pandemic levels but faces growing headwinds in the years ahead, says CIBC World Markets in a new report.
Profit margins for non-financial companies listed on the TSX index are “comfortably above” their pre-pandemic levels, the firm’s economists reported.
“The unique nature of the pandemic has generally rewarded many Canadian businesses with a quick rebound in profit margins, as the reduced price sensitivity of consumers has allowed businesses to pass on higher production and labour costs without the usual adverse impact on demand,” it said.
For now, margins are likely to remain healthy but face brisker headwinds over the longer term, the report said.
To start, rising interest rates will ultimately feed through to increased debt service costs.
“Higher rates will not derail current profitability, but will clearly work to start denting margins,” it said.
Additionally, with workers’ bargaining power on the rise, higher labour costs will eventually start to crimp margins too.
“Increasing challenges to find suitable workers, combined with increased compensation, imply that the labour factor will be a net negative for margins in the coming years,” CIBC said.
At the same time, while margins have been supported by weak competition in a number of sectors in recent years, the tide may be starting to change there, too, the report suggested.
“Is it reasonable to assume that we are reaching a limit on industrial concentration in Canada? Is it possible that the share of high-margin industries in the economy is too high? We think so,” it said.
“Technology will work at an accelerated pace to lower barriers to entry, while regulators are showing reduced tolerance to increased market power,” the report said.
Other factors, such as increased protectionism and the demand for more resilient supply chains in the wake of the pandemic, will likely also erode margins as industries seek to guard against “similar disruptions in the future,” the report noted.
“In this kind of environment, where multiple forces are working against profitability, corporate Canada will be forced to react,” it concluded.
“To the extent that the relatively easy flow of profits in the past two decades reduced the motivation to invest, the new margin reality might be a catalyst for increased capex aimed at lifting productivity. Hopefully, the long wait is coming to an end.”