How to Protect Against Inflation

Richard Hemming

In the past few weeks we have seen more and more companies being negatively affected by cost inflation pressures. We have been talking a great deal about increasing freight and pallet prices, higher trucking rates. These pressures are not going to go away, just ask management at the supermarket giants at Woolworths (WOW) and Coles (COL). You might also ask the managers at lesser known shade cloth manufacturer Gale Pacific (GAP).

What do the Statistics say?

The Forecasts for inflation have been uncertain. Whilst some analysts foresee normal inflation rates continuing, Many people have begun to note the already mentioned rising costs of shipping and transport of goods and services.

The CPI (Consumer Price Index), measures inflation rates by comparing the prices of goods and services from one period to another. As such the Consumer Price Index, currently measures a 3% inflation rate, a spike from last years Covid drop of -0.3% (ABS) and contrasted to the March 2020 rate of 2.2%, Reserve Bank of Australia 2021.

Crucially however, rising transport costs haven't fully transferred over into front-end consumer costs, as seen by Woolworths (WOW) CEO stating that "We can see legitimacy from the cost increase the suppliers are giving us but we’ve got to be very careful on how we pass those through to our customers"

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So how should investors keep their portfolio's in check?

The crucial question you need to ask of the companies in your portfolio is whether they can pass on rising prices? Corollaries include: How deep is their customer base? How strong is their price power with suppliers?

These questions are being asked and answered more and more frequently. Investors vote with their feet when they don’t like the answers. The key is to take action, such as selling stock, before any negative event occurs. This is the opposite to being reactive. As I’ll show, in an inflationary environment, it has been right to hold onto WOW, and COL, but it was also right to take profits on GAP, which we did!

The supermarkets have both noticed increasing costs, but notably their share prices have been almost unaffected and this comes in the wake of solid appreciation.

In its first quarter result this week, which we cover on page 6, Coles highlighted increasing costs, citing Covid. These costs are not going to disappear. Its market shares are down less than 2% subsequently and have returned 10% since our Buy recommendation just over six months ago (30 Apr 2021 / Issue 77).

Since late last month when WOW’s CEO Brad Banducci highlighted food inflation being “the toughest of all questions” its stock has fallen 4%, but this is off its peak. Over 12 months WOW has returned 23%.

In our Small Caps publication one of our long-term favourites has been the shade cloth manufacturer Gale Pacific (GAP), which we included in a number of our past dividend portfolios, locking in some big 200% plus returns. The crucial thing was that we sold in August at 43 cents when we anticipated costs climbing. This week Gale announced a profit downgrade due to cost inflation, sending its stock to 28 cents, down 36% at last count.

How you can Hedge Against Inflation

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Blue Chips can and do make horrendous strategic errors (remember Woolworth’s foray into Masters? Remember when Rio Tinto bought Alcan, then there was Foster’s foray into wine, the list goes on). But what they do have is pricing power because of their sheer size. This is a significant protection against the inflation we’re seeing.

The grocery retail giants will be rational and either chase market share or pass on lion share of price increases to consumers. My money is on the latter. When you are in an oligopoly life is much easier! Companies like Gale Pacific have much greater growth potential, but are vulnerable to such costs, which is why we took profits.

Timing isn’t quite as important at the big end of town. The fact that all those in our Blue Chip Value Portfolio have a history of paying dividends is extremely relevant, as is the fact that many are in cosy oligopolies. Their balance sheet flexibility gives them greater ability to keep making profits and paying dividends when times get a bit difficult, as does their ability to pass on increasing costs.

Hunting for growth is important in successful investing, but over the long-term you also need the ballast Blue Chips can provide.

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About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

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