Digging out the truffles
Inflation “surges and hits highest level in 40 years” screamed the headlines in the past week. Perhaps there is hope for my gold position, which I took in December 2020 in anticipation of inflation. Thus far, the precious metal has been as effective as a lifeboat with a hole in it.
A Bloomberg report last week indicated that economists have underestimated the monthly change in inflation in eight of the past 10 months.
The US Federal Reserve has worked hard to downplay this issue and too many economists have been lapping up that story. The Fed’s thesis that inflation would be transitory (is that a swearword yet?) was based on a normalisation in supply chains. That hasn’t happened yet, as runaway money printing has driven incredible consumer demand for goods. Supply chains cannot catch up, because the world insists on ongoing Covid precautions even when they no longer seem to be necessary.
The flywheel effect of this free money is that wage inflation has gone through the roof. And it’s not over yet, as consumer prices in the latest inflation print revealed that wage gains haven’t kept pace with levels of inflation that would scare South Africans, let alone Americans. This can only lead to even more pressure on US wages, which is tough for businesses that rely on human capital.
It can be difficult to predict the net impact on companies under these circumstances. FedEx is a great example, with the third-party logistics giant trading 50% higher than at the start of 2020. Like much of the market, it has suffered a 12% drawdown this year.
FedEx isn’t a flashy tech company with cloud computing offerings. It moves boxes from A to B and one of those two letters is inevitably North America. That’s been a profitable model during this period, as shipping volumes have rocketed. So has the “yield” (price) per shipment. An increase in volumes and pricing is the holy grail for any company.
But the logistics industry is still a people-intensive business. Humans need to unload boxes and drive trucks across the country. If consumer demand falters and wage demands increase, things could quickly go the other way for FedEx.
Investing is all about timing. Buying FedEx in 2020 would’ve been an inspired move. Buying it now is risky, as there’s plenty of scope in the chart for gains to be erased.
As some have learnt in 2022, what goes up quickly can come down even faster. If you dig through the numbers, you’ll see little evidence of any material operational improvement in the company, measured with a metric like return on assets.
Italtile is another good example of the importance of timing. The share price has risen about 23% since the start of 2020. That may not sound like an award-winning return, but the share price compound annual growth rate in 2016 to 2020 was about 3%. In that context, it’s a major acceleration.
The force behind this growth was the investment by consumers in their homes. They were forced to stay home during the pandemic, so they spent money making the place prettier.
In its latest earnings update, Italtile colourfully refers to this as the “cocooning trend” and then pours water on the romance of that image by saying that the trend has diminished significantly.
New builds and commercial projects have been slow in the past six months, so a fade in consumer spending isn’t good news for this business. Systemwide turnover (in other words, including sales by franchisees) fell 1% in the six months to December 2021, which is also a negative read-through for the likes of Massmart.
Look closer at Italtile and you’ll see that the entire gain in the share price happened in 2020.
It’s been flat for the past 12 months and I suspect that the short-term moves will be sideways at best.
So how do you identify the next winner? It doesn’t help to buy at the top of the cycle, so piling into FedEx or Italtile now is unlikely to work.
A company that caught my eye last week is Hudaco, which is up around 50% since the start of 2020.
The local industrials group posted strong headline earnings per share growth in 2021: up 56% vs 2020 and 21% vs 2019.
It declared a solid final dividend of 520c a share to take the full-year dividend to 760c, an implied yield on the current share price of 4.5%.
Net borrowings decreased significantly over the period and operating profits were 23 times higher than interest payments.
That’s good news in an environment of rising interest rates.
But here’s the best part: Hudaco talks about having pricing power to protect its margins. This is the language you want to see as inflation is rising. Hudaco may be worth a deeper look.
Investing is all about timing. As some have learnt in 2022, what goes up quickly can come down even faster