The landscape
Quarter one of 2022 was characterised by what felt like daily discussion about the topic of inflation. So rife has been this subject, that it has even crept into the lexicon of our sacred family braais. One of the key contributors to this being oil. With the number of hikes we have seen to the price of fuel, every man and their dog must by now have developed a slight anxiousness at seeing the opening statement “Kindly be informed that the Ministry of Mines and Energy has resolved to…”.
Unfortunately, due to the dependence society still has on oil and gas, the higher fuel prices have also led to increased costs of production for many of the goods we consume on a daily basis. Numerous other commodities have also seen a rise since the turn of the year. (see Figure 1)
Figure 1: Year over year percentage change in price of selected commodities
Source: Bloomberg
The end result? Our overall cost of living has risen noticeably, particularly in the past three months. Since 1 Jan 2022, year on year rate of inflation in Namibia and South Africa respectively, has progressively risen from 4.1% and 5.5% to 6.0% and 7.4%. (Considering the attention this topic has received, you would think that inflation levels are near record highs. In actual fact, inflation in South Africa only just crossed the 30-year average two months ago. (see Figure 2)). Afar, the landscape differs greatly, with the USA and UK the jurisdictions seeing 40-year highs.
Figure 2: SA Inflation rate since July 1992.
Source: Bloomberg
What has this meant for the consumer? Ceteris paribus, a higher cost of living translates to a decline in the purchasing power of the consumer. This has left the consumer with less cash to spend on discretionary items (e.g. a new car/home, a holiday in Europe) and triggered a mentality change - choosing to defer such purchases until a more stable time.
For the investor? Thoughts have shifted to how best to hedge one’s portfolio against these rising costs. That is, what decisions need to be made to position one’s portfolio to continue earning excess returns over their benchmark in a time that tends to mean reduced profit margins.
Our portfolio makeup
History shows that during times of above-average inflation, globally the three best performing sectors tend to be Energy, Healthcare and Consumer Staples. This is backed by analysis we conducted where, we identified four periods from the last 30 years which were characterized by higher-than-average inflation rates, and observed the total returns each sector yielded during said timeframes. Ranking the returns of each sector, we found that on average, the three above-mentioned sectors ranked as the best three in terms of performance. (see Figure 3)
Figure 4: Period average and standard deviation in ROEs of GICS sectors since 1995
Source: Bloomberg
*Periods selected are Jan 1995 – April 1997; Sep 1999 – Sep 2001; Apr 2004 – Aug 2006; Sep 2007 – Oct 2008
Energy featuring in the top three comes as no surprise. Many past periods of above-average inflation have coincided with, or come as a result of, surging oil and gas prices. 2008 for instance, saw the price of WTI crude oil rise from U$78 at the end of July 2007 to a peak of U$145 a year later. We saw a similar occurrence in 2000 where the price of natural gas more than quadrupled in the space of the year, peaking at U$9.78 by year end.
2022 has followed a similar trend and our Global Opportunities Fund has been positioned to benefit from this through our exposure to British oil giant, BP Plc. This former member of the “Seven sisters” is a compelling investment case as it has a lower production cost per barrel than its peers; Exxonmobil, Chevron and Shell, and trades at the lowest P/E of the four (a consensus P/E of 4.0).
The attractiveness of Consumer Staples and Healthcare, in contrast, is underpinned by a few factors. Firstly, they are inherently defensive industries. i.e. industries which provide goods and services that will always be in demand regardless of the phase of the business cycle. Economists term this as demand being “inelastic”. The sticky demand of their products place pharmaceuticals and staple product retailers in the position to pass on inflation to their customers better than other industries.
Demand for goods such as a new phone or new car on the other hand typically wanes when the consumer’s purchasing power weakens, much less when manufacturers then also hike up their prices.
With Consumer Staples and Healthcare, we also found that these sectors on average provide the best returns on equity (ROE) (see Figure 4). It is thus not a surprise that they become the sectors to turn to during periods of uncertainty and overall market downturn as investors seek shelter in companies that most efficiently provide positive returns on investment.
The consistency of Consumer Staples and Healthcare is also reflected in the fact that their returns show the least volatility of all the sectors. (see Figure 4) These factors lend to the suitability of these sectors as hedges against the current inflationary environment that we find ourselves in.
Figure 4: Period average and standard deviation in ROEs of GICS sectors since 1995
Source: Bloomberg
These superior ROEs, the defensive nature of their products, and accumulated brand value, position companies within the Healthcare and Consumer Staples sectors to pass inflation onto their customers, without causing significant strain to their revenues.
Considering the number of sub-industries that fall under Consumer Staples, being the curious individuals that we are, we dug further to uncover which of the sub-industries between Food & Staples Retailing, Beverages & Tobacco and Household & Personal Products provided the better ROE and margins. We found that Beverages & Tobacco ranked highest within their peer group in terms of these metrics, notably during times of above-average inflation. In our view, this owes primarily to one factor – the addictive nature of their products. This by design adds a further layer of stickiness to product demand. It should be noted however that we place great emphasis on companies that are demonstrably good corporate citizens and actively work towards having a positive impact on society. To this end, since 2015 Anheuser-Busch InBev has had in place a "Smart Drinking Initiative" which seeks to contribute positively towards global efforts to reduce the harmful consumption of alcohol."
Our portfolios have been positioned to provide market-beating returns this year through our exposure to these key sectors (Energy, Healthcare and Consumer Staples, particularly Beverages & Tobacco).
In our SA multi-asset funds, we are overweight Consumer Staples with British American Tobacco firmly high up in our top 10 holdings. Since 1999, this company has averaged an ROE of 37.2%, only failing to provide a double-digit ROE twice.
Anheuser-Busch InBev is another that has screened well in our process.. In the group’s recent 1Q22 earnings release, figures suggested an ~11.1% increase in the cost of each hectoliter (hl) sold as compared to a year ago. However, in clear demonstration of pricing power, the group managed to pass on 70% of this to their customers, experiencing a 7.8% growth in revenue per hl sold. All the while, the group sold 2.8% more hectoliters compared to the comparable quarter last year.
“In good times, it's great to be a beer company. In bad times, it’s very good as well!”, remarked Anheuser-Busch Inbev CFO, Fernando Tennenbaum.
Taking all of the above into consideration, British American Tobacco and Anheuser-Busch InBev especially put us in good stead.
In our Global Opportunities Fund, our position on Energy and Healthcare is more pronounced where, in addition to being heavily overweight Consumer Staples, we are also overweight the two above sectors through stocks such as BP, Pfizer and United Health. The latter two are industry leaders in their own right. Pfizer has a brand built on innovation and has provided a 30-year average ROE of 22.8%, whilst United Health is the largest health insurance group in the US by membership and has provided an ROE of 22.4% over the same period.
In terms of commodities, rallies in commodities such as Iron ore and Nickel placed Anglo American (one of the top 10 holdings in our Balanced Fund) in a favorable position earlier on in the year. The price of Iron ore rose as much as 29.0% by start of April before cooling off, whilst the price of Nickel more than doubled before peaking on 4 March. Mining of the two commodities collectively made up 27.1% of Anglo American’s revenue in 2021.
Although commodity prices have since cooled off, the world’s desire to migrate towards a more decarbonised future provides a positive long-term outlook for platinum group metals (PGMs) and copper.
PGMs such as platinum are used in the development of fuel cell technology and thus would serve a role in the development of a hydrogen economy, whilst copper is an input in the production of EVs and the associated charging infrastructure. This is an area which legacy car companies are increasingly investing in, as reflected by Ford’s recent announcement of a series of deals to accelerate its shift to electric vehicles (EVs). Significant supply of base metals is necessary for this transition.
Higher inflation has very recently begun to be accompanied by more pessimistic outlooks on growth and forecasts of a recession. In their 7 June press release, the World Bank revised their forecast for global growth downward, predicting a 2.9% growth for 2022, down from the 4.1% that was anticipated in January or the 5.7% observed in 2021. The reasons cited: near term activity, investment and trade being disrupted by geopolitical events worldwide, and withdrawal of monetary policy accommodation (rising rates).
Namibia is predicted to fare similarly. Our central bank, Bank of Namibia, and the IMF forecast growth rates of 3.0% and 2.8% respectively, lower than the 3.4% and 3.6% predicted earlier in the year. Should this materialise, the energy sector and suppliers of commodities may likely see reduced demand and lower returns, however our positions in Consumer Staples and Healthcare will once again serve us in good stead. These two defensive sectors also provide value during times of recession, for the same reasons provided earlier. We are confident that in this scenario, our portfolios will continue to hold resistance and continue to provide market-beating returns.
