In June, the Consumer Price Index (CPI), a measure of inflation, rose 7.9% year-on-year. This was in line with the Bank of England’s forecast, but it’s still almost four times over their 2% target.
For businesses, high levels of inflation can cause problems. Higher input costs make it harder to earn the same profit per sale as you did before, and workers usually demand higher wages to face the rising costs of living. All in all, it's usually a tricky thing to manage.
But some businesses are better equipped to ride the inflation wave compared to others – here we look at three.
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GSK
The pharmaceutical sector has some attractive characteristics in the face of an inflationary environment.
Sales of life-saving therapies can be considered essential, so aren’t being held hostage to the current squeeze on consumer spending. That’s been proven over time by the consistent growth in volumes of prescribed medicines, despite shocks to the economy.
An ageing population, and multi-billion dollar research and development budgets are drivers we think will hopefully help maintain this trend going forward.
The pharmaceutical industry’s defined by high barriers to entry and a culture of science-led innovation. That lets drug development companies make a healthy profit from successful medicines.
Input costs haven’t been rising as much compared to other industries, and gross margins across the sector have been growing recently. There’s some political pressure to keep drug pricing in check, but the impact on profits might be limited.
Looking at GSK in particular, having demerged its consumer health division Haleon last year, GSK now focuses solely on scientifically complex therapeutics.
So far, GSK is making good on the majority of its expected 2023 pipeline delivery milestones. One example is the recent approval of Arexvy. This is a first-in-class vaccine for respiratory syncytial virus, which is responsible for 160,000 deaths worldwide each year.
GSK's valuation is below the long-term average, and significantly less than lots of its peers. We think the relatively low price-to-earnings ratio and prospective yield of about 4% makes this an interesting company to watch. Yields are variable and not a reliable indicator of future income.
Closing the valuation gap with other companies in the sector will depend on strong execution of GSK's growth strategy and clinical pipeline. But new drug approvals are never a given, and even established therapies can fall foul of the regulators or be unseated by new entrants to the market.
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LVMH
Luxury brands don’t usually feel the sting of inflation as sharply as other businesses.
Customers shopping for these brands often tend to be high-net-worth individuals, meaning they’re undeterred by sky-high prices. So, spending typically stays strong when there’s a downturn to the economy and inflation bites.
Few companies epitomise the luxury sector like LVMH. It’s a luxury goods group with high-quality names like Louis Vuitton, Christian Dior, Givenchy, and TAG Heuer under its wing – offering envious breadth and scale.
Revenues rose from €18.0bn in the first quarter last year to €21.0bn in the first quarter this year, outpacing the uncomfortably high level of inflation seen across many parts of the world.
And the reopening of China should provide some tailwinds for demand this year too, helping push revenues higher. The Asian market, excluding Japan, already accounts for more than a third of income, so we expect strong momentum for LVMH as China rebounds and relatively weaker comparative periods roll through.
Being able to charge such prices for products means operating margins are healthy, currently floating in the mid-twenties.
Adept management is a serious asset too. Group CEO, Bernard Arnoult, has been at the helm for the best part of five decades. He’s the largest shareholder and his family owns 48% of the shares, which probably explains the focus on long-term success.
On the flip side, this raises questions about succession plans. When the day comes for him to step down, there’s likely to be some short-term turbulence. And longer term, there’s no guarantee his replacement will have the same level of success.
The valuation’s also running slightly ahead of its long-term average on a price-to-earnings basis. And compared to peers, LVMH is trading at the higher end of the pack. That’s understandable, given its market position and defensive characteristics, but increases the risks of ups and downs.
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Tritax Big Box REIT
Real Estate has historically held up relatively well in periods of high inflation and low growth to the economy. Rental income tends to keep up with, or sometimes outpace, inflation.
But higher interest rates have typically negatively affected performance of REITs (Real Estate Investment Trust) – so it's a bit of a see-saw effect.
Looking at Tritax Big Box, this REIT generates income by renting out giant warehouses.
Despite inflation-linked doom and gloom hanging over, for lots of Tritax's retail customers building a strong logistics network is non-negotiable. That's helped the group add to its rent collections.
Highly desirable assets mean attractive deal terms, such as upwards-only rent reviews. This is one of the reasons it should hold up relatively well if inflation stays high, and a wide range of high-quality tenants adds some security to the rental payments it receives.
But aside from collecting rent, development is key to the strategy. That involves building things like distribution centres and renting out or selling at a profit. Central Banks have responded to higher inflation by raising interest rates, which puts pressure on the value of the portfolio and increases the cost to fund development.
But recycling assets is important, as REITs have to pay out a large portion of their earnings to investors. Proceeds from sales are key to reinvesting in new projects, so recent news that Tritax is back in the game after a period on the side-lines was welcome.
Overall, collecting rents that can rise with inflation is an attractive quality and in our view the valuation doesn't look too demanding. We expect demand for more warehouse space to increase over the long term but remain cautious of the short-term impact that higher rates will have on development.
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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
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