By Michael Brush
Wednesday’s inflation report was a reminder that investors will be scrutinizing earnings reports to weed out companies whose profit margins are being eroded by rising prices.
The inflation rate clocked in at a 30-year high of 5.4% in September, up from 5.3% in the previous month, the government reported Wednesday. Food and energy prices rose the most.
That could damage your stock portfolio, but there’s a fix for that. And it’s pretty simple.
In this era of elevated inflation, favor companies that have the luxury of pricing power — but whose costs aren’t increasing. This gives them the best of both worlds.
The hard part is finding companies that fit the bill. I recently checked in with three money managers and asked them to give me — and us — their best ideas.
Here are seven companies they say check all the right boxes.
At Gabelli Funds, portfolio managers strongly favor companies with moats and durable competitive advantages. These companies also normally have pricing power. So, Gabelli is a good place to turn for names that benefit when inflation rages.
The cable and entertainment company Comcast (NAS:CMCSA) is a solid example, says Chris Marangi, co-chief investment officer at Gabelli Funds. The largest cable operator in the U.S., Comcast has a moat because it is so costly to get into the cable business.
Meanwhile, Comcast still has room to raise prices and win over customers from competitors including AT&T (NYS:T) and Verizon (NYS:VZ) . The adoption of Zoom (NAS:ZM) during the pandemic, and the popularity of gaming and video platforms like Netflix (NAS:NFLX) all support ongoing demand for cable.
Comcast also has room for price increases at its Universal theme parks, and for advertising on its NBC and Telemundo broadcast networks.
“Comcast’s margins are high, and they aren’t impacted by inflation,” says Marangi.
Union Pacific (NYS:UNP) connects 23 states in the western two-thirds of the country by rail, providing a critical link in the global supply chain. It serves key ports on the West Coast, the Gulf of Mexico and the Great Lakes, transporting a mix of farm products, energy, industrial goods and autos.
While it has labor and fuel costs that are going up, most of its costs are fixed. That’s because they’re historical outlays for rails, cars and rights of way. Yet the rail company can raise costs along with truckers in the current tight shipping market, notes Brian Barish, CIO at Cambiar Investors. This gives Union Pacific the best of both worlds.
“They operate with huge pricing umbrella vis-a-vis the truckers,” says Barish. “But their costs remain contained.”
The chances are pretty high the last plane you were in was not owned by your airline. Instead, it was probably leased. And it was likely supplied by Air Lease (NYS:AL) , one of the biggest players in this space. Air Lease serves 112 airlines in 60 countries. Its costs are largely fixed since it already bought the aircraft. But like a retiree laddering into various bond maturities, this company staggers its leases so that some are always rolling over. When they do, Air Lease can raise prices. It also benefits from rising aircraft prices, since this boosts the value of assets on the balance sheet.
Air Lease is a reopening play as well. The delta variant of Covid is backing off. As this continues, people will travel more.
“Commercial aviation is depressed, but all signs point to a full reopening in 2022,” says Barish. “Once we get to reopening, we are going to discover the world is short planes.”
Many of the older, parked planes will be written off, because it is expensive to bring them back into service. Airlines also want to replace aging aircraft with fuel-efficient jets. Air Lease benefits from big-picture trends as well, like the emerging middle class in many countries around the world. People travel more as they earn more.
Barish thinks these trends will bring the shares of this value play back up closer to historical levels, benefitting anyone who owns the stock now, like him. Air Lease trades for around .7 times book value, but historically it trades at slight premium to book value, he says.
This is a waste-management company operating about 186 landfills and 76 recycling centers in 41 states. Republic Services (NYS:RSG) paid for its landfills, recycling and disposal centers years ago. But its contracts provide for rate increases indexed to inflation, says Marangi at Gabelli Funds. Republic Services also benefits from strong economic growth and household formation since that tends to increase waste.
There’s also an opportunity to grow through acquisition, as this is a fragmented sector. Two other companies in this space that Gabelli owns are Waste Management (NYS:WM) , the biggest landfill operator in the U.S. and Canada with about 268 landfill sites; and Waste Connections (NYS:WCN) , the third-largest solid-waste services company in North America.
Through subsidies, Matson (NYS:MATX) provides ocean freight transport services connecting several Asian countries to the U.S. It does have some variable costs that are going up, such as spending on fuel and labor. But most of what it needs to operate — its vessels and terminals — were bought years ago. Matson’s owned vessels represent an investment of about $2.2 billion. The company also has an asset-light division providing logistical support, like transport brokerage services.
This puts Matson in the advantageous position of having substantially fixed costs, but also the power to raise prices in the current tight shipping market.
“The cost of shipping has gone way up, and Matson benefits from that,” says Fall Ainina, deputy director of research for James Investment.
Despite this favorable positioning, Matson’s stock looks cheap, he says. It has a forward price-to-earnings ratio of around 9.6, compared to a historical P/E of over 15. The company also has high operating margins, relatively low debt levels and decent free cash flow, says Ainina.
A word of warning
If you do well in inflation plays like these, a word of warning to you. Don’t buy into the theme for the long term, because inflation really is transitory.
Capital goods spending has really taken off. This leads to a greater mix of machines and technology compared to labor, which boosts productivity, defined as output per dollar spent on labor. Companies that see productivity gains, or “get more out of each worker” even if they are not working any harder, feel less pressure to pass along rising costs to their customers.
Meanwhile, the inflation slayers that have kept a lid on rising prices for years, are still out there. They include global trade and ongoing advances in technology, both of which put downward pressure on prices.
Then there’s the aging of the population. Older people spend less, which eases upward pressure on prices, especially when older people retire. During the pandemic, baby boomers threw in the towel in droves, and headed into retirement. A record number, 3.2 million, of them retired in 2020 compared to 1.5 million the year before.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested CMCSA and UNP in his stock newsletter, Brush Up on Stocks . Follow him on Twitter @mbrushstocks .