Pricing Power Essential to Earnings Growth, not Where Investors Might Expect to Find It

13 April 2022: The return of inflation means that investors must get a sense of how much companies can pass on costs and maintain margins.

February interim profit reporting season showed that the type of company that has pricing power has changed, says Reece Birtles, Chief Investment Officer of Martin Currie Australia.

Birtles says: “As the inflation dynamic becomes more significant, the ability of companies to pass through input cost increases to their customers is one of the most significant themes for investors to understand. Companies
that have done well in this respect either have in-built inflation protections for their revenue streams and supply chains, or inflation leverage in their profit margins.

“Until recently, service providers – typically growth-stye stocks – were more likely to be able to increase prices. But now it is goods companies that appear to have a better ability to quickly pass through their input cost
increases in a transparent manner.

“Service companies are seeing higher costs in IT, compliance and wages, but with less price elasticity, meaning they cannot push prices up and still maintain sales.”

During the February reporting season, Martin Currie portfolio managers and analysts met with the management teams of more than 100 companies to get an understanding about how the inflation story is playing out at the earnings level. Some examples of companies whose results showed strength in this respect include:

 

• Packaging manufacturer Amcor has seen higher costs but it has been able to increase prices without losing sales. Due to the essential nature of the goods they sell, Woolworths Group and other supermarket businesses are doing a solid job of holding their gross profit margins by passing through the rising cost of goods.
•  Accelerating inflation has been a positive for Scentre Group’s regional and super-regional shopping centres. They have high tenant occupancy and rental contracts with CPI-adjusted lease renewal mechanisms.
• Many infrastructure and utility companies also have CPI-linked contracts. Gas pipeline company APA Group’s operating expenses are a modest part of revenues, while revenue contracts are typically long-term take or pay with CPI-linkage mechanisms. As inflation increases, the dollar value of cashflow will increase.
• Banks face elevated risks as households come under pressure from higher costs and interest rates.But the banks are well provisioned, as are households, and their net interest margins will rise as interest rates rise. On balance, higher rates are positive for banks.

Birtles says the February 2022 results were better than expected. Close to half (43%) of companies beat consensus forecasts for earnings per share (EPS) by more than 2%, while only 26% reported EPS that were
below expectations.

Strong consumer spending improved sales and revenue. Following the results, more companies received upgraded than downgrades across sales, EPS and dividend per share forecasts.

“In these upward revisions there is a skew to companies that are positively exposed to the reflation dynamic, rising interest rates and rising commodity prices. These stocks are generally found in the resources, financials
and real assets sectors,” Birtles says.

In factor terms, growth stocks have seen quite severe price reversions and there is a significant turn in the performance of Australian and global value stocks, many of which will be the ones to benefit from higher inflation.

“Australia has very high-quality financials that will benefit from rising rates and resources companies that will benefit from the Russia disruption and the demand for net-zero transition. Now, more than ever, is the time to
allocate to value,” Birtles says.

For all media queries, please contact Simrita Virk
E: [email protected]

About Franklin Templeton
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organisation with subsidiaries operating as Franklin Templeton and serving clients in over 155 countries. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management and technology solutions. Through its specialist investment managers, the company offers boutique specialisation on a global scale, bringing extensive capabilities in equity, fixed income, multi-asset solutions and alternatives. With offices in more than 30 countries and approximately 1,300 investment professionals, the California-based company has 75 years of investment experience and approximately A$2.2 trillion in funds under management as of 31 December 2021.

For more information, please visit franklintempleton.com.au

Disclaimers

This publication is issued for information purposes only and does not constitute investment or financial product advice. It expresses no views as to the suitability of the services or other matters described in this
document as to the individual circumstances, objectives, financial situation, or needs of any recipient. You should assess whether the information is appropriate for you and consider obtaining independent taxation, legal, financial or other professional advice before making an investment decision.

Please read the relevant Product Disclosure Statements (PDSs) and any associated reference documents before making an investment decision. In accordance with the Design and Distribution Obligations and Product Interventions Powers requirements, we maintain Target Market Determinations (TMD) for each of our Funds. All documents can be found via www.franklintempleton.com.au or by calling 1800 673 776.

Issued by Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827).

Copyright © 2021. Franklin Templeton Australia Limited. All rights reserved.