Estate agents, drinks makers and ten-pin bowling company are among the several UK stocks that appear well-positioned to combat high inflation, according to fund managers.
In December UK inflation breached 30-year highs of 5.4%, putting pressure on investors to make higher returns or risk losing money in real terms.
With low bond yields and savings accounts paying near 0% interest, higher-risk investments such as stocks have been the logical choice.
But volatile markets have not made it easy to decipher which stocks to own and which to avoid. One of the ways savers can preserve their purchasing power is by investing in companies geared to wider economic growth or those that are able to pass-on rising costs.
Below Trustnet asked UK fund managers for the one company they are most confident can navigate higher inflation and potentially rising interest rates.
Beazley
Source: FE Analytics
Alexandra Jackson, manager of the Rathbone UK Opportunities fund, said the UK has no shortage of interest-rate sensitive picks to choose from thanks to its value bias and abundance of banks and energy stocks.
“But if, like us, you look for stocks to own over a slightly longer time period, beyond the point when central banks decide they have hiked enough, perhaps these over-regulated and under-invested sectors don’t look so appealing,” she said.
The manager pointed to London insurer Beazley as one potential stock to consider.
“The insurance sector tends to be positively correlated with yields but right now there is a further dynamic at play,” she said. “Premiums are finally going up aggressively after many years of falling behind claims inflation. So, profitability for insurers looks set to improve materially this year after a few tough years.”
Electrocomponents
Source: FE Analytics
Margaret Lawson, manager SVM UK Growth fund, agreed that the best investments to combat inflation might not be the most obvious asset plays such as resources and banks.
She said: “Inevitably, price rises become political and businesses in the eye of the storm risk windfall taxes and price constraints.”
Lawson argued it is better to look at distributors – companies that can naturally pass on rising prices and with operational leverage.
She said: “Electrocomponents is diversified across service channels and geographically, with a small share of a big global market that typically grows faster than GDP. It is a cash generative business and has levers to continue growth in the current environment.”
Although the firm faces some freight and labour cost pressures, it has been successful in holding on to staff, maintaining pricing discipline and winning new customers and with a strong management team, this gives the business good organic sales growth and stable profit margins, she said.
Additionally, as a business-to-business (B2B) company Electrocomponents is likely to be less exposed to weaker consumer confidence as inflation squeezes spending power, she said.
“This probably also means being less of a political target along with its reduced risks from supply shortages,” said Lawson.
Diageo
Source: FE Analytics
Chris Smith, manager of the Jupiter UK Growth fund picked Diageo as he argued it benefits from strong pricing power.
“While this has always been important, in today’s inflationary environment, true pricing power has become critical in order to pass on rising costs, rather than face a reduction in profit margin,” he said.
“With a portfolio of extraordinary, prestige spirit brands (plus Guinness) and loyal customers, it benefits from a virtuous self-reinforcing circle: the widest distribution of price points and category brands equals partner of choice for distributors which in turn equals eater advertising spend , strengthened brand equity, greater pricing power, lower unit costs via scale economies and significantly higher gross margins versus most other FTSE 100 companies, which protects Diageo’s earnings from cost inflation.”
Belvoir
Source: FE Analytics
Alex Wedge, co-manager of the Liontrust UK Micro Cap fund, picked real estate franchise firm Belvoir as he “loves franchise businesses”.
“They harness the power of the entrepreneur to thrive in times of prosperity, and navigate times of adversity.”
It is a good example of a franchise business that can exhibit resilience during inflation, he said, because the firm gets income as a percentage from franchisees, which shields it from any potential cost pressures.
With average rent in the UK up 8.3% year-on-year, the fund manager said rental inflation should be a positive for Belvoir and that higher interest rates – although not good for continued house price inflation – can increase activity in the mortgage market as homeowners look to switch to fixed deals, helping the firm’s financial services division.
Phoenix Group
Source: FE Analytics
Will Bradwell, portfolio manager in the Franklin UK Equity team, picked insurance firm Phoenix Group. Although most would traditionally associate inflation and interest rates with banks, he said the lagging insurance sector could also work as play against higher prices.
“As inflation rises the value of liabilities for life insurers falls which means distributions to shareholders can increase,” he said.
He picked Phoenix Group for two reasons. First was the management team, which he said has “consistently beat expectations”. Second was that “the business has now reached a scale where dividend growth can be supported through, amongst other avenues, the bulk purchase of annuities”.
Ten Entertainment Group
Source: FE Analytics
Laurence Hulse, co-manager of the LF Gresham House UK Smaller Companies fund, picked Ten Entertainment Group, an operator of ten-pin bowling venues.
He said the management team had proven adept at managing input cost inflation over the past year – particularly labour costs, which they have combated through incentivisation of staff.
“Even more impressive has been the investment into digital pricing mechanisms and overhauling the CRM during lockdown. Along with the strong market position, this is allowing the group to recover any unavoidable inflation,” he said.
In addition to its ability to manage inflation, he also said there are further drivers of upside for the company.
“It is ideally placed to capture growth in the ‘experiential leisure’ trend through refurbishment and improved use of technology to drive footfall, and it continues to roll out new sites at a rate of three to four new venues every year,” he said.
IG Group
Source: FE Analytics
Seb Jory, fund manager at Tellworth Investments, selected IG Group as his stock pick to weather rising inflation and interest rates.
He pointed out that most of the company’s operating costs are salaries and bonuses, and its high margins of 40% gives it a good buffer on wage inflation.
“Indeed, its pricing power – or ability to pass on input inflation – must also not be underestimated,” he added. “Rightly or wrongly, it is quite an opaque marketplace and it can be difficult for spread-betting customers to build up a perfect picture of the price differences amongst operators.
“A small move out in ‘spreads’, or perhaps simply higher stock index levels that the client is trading, can comfortably compensate the business for the higher personnel expense.”