TOL - 28th Nov, 2022
How to beat the inflation blues (and 2 stocks to do so)
If you've been noticing a little less cash in your wallet recently, it's very likely that inflation is to blame.
For the 12 months until the end of September, the prices of fruit and vegetables rose more than 16%, while dairy products increased by around 12%. Fuel prices, which thankfully have dropped from their peak, are still up 18% for the year. Energy bills, however, are still on the rise, with gas and other household fuels lifting nearly 11% in the September quarter. Ouch!
You've probably also noticed that inflation hasn't been kind to share markets. But some sectors (and stocks) are far better placed to play it.
Here, Bell Direct's Grady Wulff was joined by Blackmore Capital's Marcus Bogdan and Firetrail Investments' Blake Henricks for their thoughts on whether inflation will remain sticky into the new year, as well as the top sectors and stocks to outperform if it remains anywhere above central banks' target levels of 2-3%.
Note: This episode was filmed on Wednesday 23 November 2022. You can watch the video, listen to the podcast, or read an edited transcript below.
Edited Transcript
Grady Wulff: Hello and welcome to Livewire's Buy Hold Sell. I'm Grady Wulff. And as you may have heard or read Australia's CPI is set to peak at 8% by the end of this year. So we thought we'd take it to the professionals to see exactly how they're positioning their portfolios to tackle the inflation blues. Joining me today are Firetrail's Blake Henricks and Marcus Bogdan from Blackmore Capital. Welcome gents.
I'll start with you, Blake. Let's start with the basics. Every time we see CPI data come out in the quarter, markets move drastically. Is inflation really negative or positive for investors' returns and savings?
Blake Henricks: I think inflation is undoubtedly negative. So people are feeling great if they have savings. You can now get a 4% term deposit, but inflation's running at 7%, food bills are up 15% and electricity bills are up 20%. You're not keeping up with inflation. So I think inflation's bad for savers, investors, and pretty much everyone.
Grady Wulff: Marcus, do you agree?
Marcus Bogdan: Yes, I do. It's definitely bad for investing and you've seen that this year as interest rates have risen, price-to-earnings ratios have fallen from 18 times to 13.5 times. So absolutely negative for stocks and for investors. You're right Blake. You can get 4% on a term deposit, but if inflation's running at 7%, you're still going backwards. So both for stocks and savers it's a negative.
Strategies to win in an inflationary environment
Grady Wulff: Well, we agree here. With inflation running at 7.3% in the September quarter, what strategies are you employing to win in this current environment?
Marcus Bogdan: Well, you have to hold companies that have pricing power, that's absolutely essential. So they either have pass-through mechanisms in their contracts or they have the ability to keep on pushing prices through so they don't absorb that cost impost.
Grady Wulff: Blake, what strategies are you employing?
Blake Henricks: When I think about inflation, I think about pricing power as Marcus has talked about. Also, low gearing, because as inflation comes around, interest rates follow, and if you've got a lot of gearing, you've got a lot of interest and that's downgrades. But also low multiples, the lower the multiple, when interest rates are high, there's less devaluation. So I think there are a couple of things you can look for. It's hard to find the perfect company because those with pricing power typically have high multiples, so it's not super easy. So I feel for a lot of investors out there, but those are some of the things we'd be looking for.
The outlook for inflation: Sticky or not?
Grady Wulff: Reading the markets has definitely not been easy. A lot of market analysts are expecting inflation to peak at the end of the year. Are you thinking it's going to come off really sharply after that or is it going to remain sticky for a little while to come?
Blake Henricks: There are a couple of components to it. So the first one I look at is supply chains, they are fully fixed. The supply chain tightness that happened - demand went through the roof at the same time as supply chains weren't working and prices went out of control. They have all come back to pre-COVID levels, in some cases lower than pre-COVID. So that'll be deflationary next year. On the energy side, because that's one that really took off, especially through Russia, those prices have sequentially stopped going up for the moment. And so by the time we get to March or April next year, that'll be deflationary as well, assuming they hold where they are. But the labour force tightness is the one that just keeps on trucking along. In Australia, it's not actually too bad at the moment. We're running at around 3% in EBAs, which is 42% of the workforce. Some of the other numbers are a lot higher, but in the US the companies we talk to are saying that the labour market remains very, very tight. So I'd expect supply chains down, energy down, but labour to keep going higher.
Grady Wulff: Marcus, thoughts?
Marcus Bogdan: I partially agree and partially disagree. On the supply chain, I think it's depending on what jurisdiction you're in and what industry you're in. They've certainly improved. And not only in supply but in price. On energy, I think that's the big question mark. And the supply issues around energy I think will continue to hold prices higher. Where I agree is that we've got chronic labour shortages in the developed world, and I think that they will continue. So I think inflation will moderate, but I think it'll stay at a higher level than what the central banks are aiming for between 2% and 3%.
Sectors that will continue to suffer
Grady Wulff: Now, honing in a little bit further, which sectors do you expect to continue suffering in this environment?
Marcus Bogdan: Well, I think what Blake said earlier on, I think the high PE stocks will continue to be under pressure because I think interest rates will stay stronger for longer. And also cyclicals. I think it's too early to move on cyclicals because I think we are going into an earnings slowdown and that will affect those types of companies more prominently.
Grady Wulff: Blake, which sectors are you seeing as the ones to avoid?
Blake Henricks: I'll call out one sector and its supermarkets. Supermarkets is a great defensive sector to invest in that benefits from inflation. And if you run a simple model you say, 'Well, as inflation comes through, the basket goes up. If you hold gross margin percentages flat, gross profit dollars grow and therefore this great earnings growth happens with inflation.' But the reality is margins are determined by competition and competitive dynamics. And that competitive framework isn't really changing at the moment. It's very stable, it's very good, but our view is that supermarkets aren't going to be huge winners from inflation. To date, that's been proven to be true because they've struggled to pass through some of those costs and we haven't seen big earnings upgrades. And the multiples are fairly extended because people are gravitating towards those defensive sectors. So if there's one I'd call out, it'd be supermarkets as a controversial loser from inflation.
Sectors to continue to benefit from inflation
Grady Wulff: Now, on the contrary, which of the sectors do you think will benefit or perform well in the inflationary environment?
Blake Henricks: For me, I'd just go to the sources of inflation and energy would be one of those. We've talked extensively in the past year about how hard it is to bring on new energy supply. And so as these prices rise, which are one of the key causes of inflation, I think that's a sector that's very attractive.
Grady Wulff: Marcus?
Marcus Bogdan: I agree. Materials and energy, and real assets in an inflationary environment, it's where you want to be positioned.
2 stocks to beat the inflation blues
Grady Wulff: Absolutely. Well, which stock do you believe can help investors beat the inflationary blues?
Marcus Bogdan: Well, I think Brambles (ASX: BXB) is a great example of that. It's been able to pass through the surcharges, the higher lumber prices and higher transport prices, and it's also had pricing power. And they've had pricing power because their customer base has been on allocation, they've got very good contracts there, and it is facing into defensive industries. 80% of their revenue is consumer staples. So I think that Brambles is a stock that continues to give you some pricing power.
Grady Wulff: And Blake, which one is beating the blues for you?
Blake Henricks: It would be in the energy sector, I'd pick Santos (ASX: STO). So Santos is undertaking two large projects at the moment. Once they're completed, you're going to have 20 years of very stable volumes. And it's pricing in US$60 a barrel at the moment, current prices are around US$90, so they're generating a lot of free cash flow. And with low multiple, real assets and inflation hedge, Santos would be the one for me.
Grady Wulff: Well, that's all we have time for today on that episode of Livewire's Buy Hold Sell. I'm Grady Wulff, and I hope you enjoyed that episode as much as I did. If you did, why not give it a like? Don't forget to subscribe to our YouTube channel. We're adding so much great content every single week.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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