The global economy is affected by a supply shock as we face critical issues in the supply chain, inflation which is at a new high, and rising interest rates.
The ongoing geopolitical conflict in Ukraine is exacerbating shortages of some goods, partly due to the sanctions imposed. Having said this, even before Russia’s invasion of Ukraine, commodity prices were surging globally mainly due to supply-chain disruptions brought about by the Covid-19 pandemic. The surge in global commodity prices came at a time when US inflation was already high.
US inflation rate is mostly driven by the tightened monetary policy, hence economy in the US is expected to slow. On the other hand, inflation in the EU and Euro area is mostly caused by short-term volatility in the prices of key products and as a result, it is expected to be transitory. The likelihood is that inflation will remain high in the short-term, as supply chain issues persist and also due to instability caused by the war between Ukraine and Russia. Studies show that inflation is expected to go down to the Federal Reserve’s 2% medium-term target by late 2023, whilst the Euro Area Inflation Rate is projected to ease extensively in 2023 to 2.9%.
Economic data shows that Malta’s annual inflation rate surged to 7.4% in September 2022, hitting an all-time high since records began back in 1997.
High inflation rates are putting pressure on Central Banks to increase interest rates and tighten their credit to help combat the soaring inflation.
How does inflation impact the value of a company?
The value of a company is ultimately driven by expected returns to the buyer. The higher the expected future profits the higher the valuation.
The impact of inflation on the enterprise value all ties into the impact it has on the expected future cash flows, growth and business risk. Businesses in riskier industries that are more exposed to economic and market fluctuations may see their costs of equity increase more than companies within more stable industries. On the other hand, companies with substantial, constant earnings and low levels of debt tend to cope better in inflationary environments and have better purchasing power.
Company valuations are often based on performance indicators of a company, like EBITDA and EBIT. Hence, if increases in costs cannot be shifted onto the customers, this would have a negative impact on the EBITDA / EBIT of the company and consequently also to the company’s value.
Although the current situation is challenging for businesses, there are some possible actions which companies may take; such as implementing pricing strategies to offset increases in costs with an increase in its prices, innovating the business operations with digitalisation processes and/or sustainability measures, etc.
In a nutshell, increasing financial uncertainty, inflation and rising interest rates tend to impact an enterprise’s valuation negatively.