As a child of the 1960s and 1970s, I remember my mother peeking into her purse and worrying about how she could stretch the household income to cope. inflation. She had an encyclopedic knowledge of supermarket prices, built from years of economics.
The worst point was 1975, when inflation peaked at 24.2 percent. For much of the past 25 years, it has hovered at about 2 percent. For many of those who find double-digit increases in energy bills and at the gas station, this new era of inflation may be a shock.
The factors that drive it have evolved over the past six months. In the spring, prices were compared with those of a year earlier, in the depths of the first restriction. This was not surprising when the prices of e.g. used cars was sharply higher. A car, second-hand or not, was of little value during lock-in.
More recently, it appears that price increases have been the result of scarcity as companies struggle to keep up with recovery. Stories of port blockages and driver shortages worldwide. Some of these blockages will no doubt start to clear up, but it looks like others will continue.
The other big factor is wage inflation. Most of us over the last few years have been happy to just be at work, so there has been little pressure for wage increases. Now it’s time to catch up.
Mix in this the way Covid-19 has led many to reconsider whether they really need that low-paid job and suddenly many large employers have to raise wages significantly to attract and retain workers. Inflation, whether from wages, fuel or raw materials, reduces company margins, especially if it is not accompanied by booming economic conditions.
How should this affect your choice of shareholding? Some sectors, such as the hotel and entertainment industries, are recovering, but rising labor and energy costs are hurting profit margins. Share prices of many companies in these sectors have fallen flat.
Other sectors’ reputations for dealing with inflation may be exaggerated. Manufacturers of popular consumer goods, for example, tend to insist that their brands are strong enough to pass on any inflation costs in higher prices. The evidence suggests that this is not always the case.
Take Beiersdorf, which makes Nivea cosmetics. Analysts expect its operating margin (sales minus the cost of manufacturing and selling the goods) to fall from 15 percent in 2019 to about 12.8 percent this year, according to Bloomberg. A small drop in operating margins could have a big impact on what is left for shareholders after deducting interest and taxes – the net profit margin for Beiersdorf drops from 10 percent to about 9 percent of sales.
This partly explains why equities have underperformed the global equities index by 25 percent over the past year. Unilever, which makes Dove soap, Häagen-Dazs ice cream and many other well-known consumer brands, is in a similar position.
By way of contrast, L’Oreal, one of our favorite holdings, seems to be able to pass on higher costs as their customers are willing to pay a little more for their favorite perfumes and cosmetics. Net income margins are stable at 15.5 percent and equities have outperformed the index over the past year despite concerns about declining demand from Asian consumers.
The list of companies claiming to have “price power” is unrealistically long. It’s time to question the figures, examine costs carefully and perhaps think more creatively. While my mother was worried about how she was going to pay for the rising grocery bill, I was happily distracted while watching TV Western, Casey Jones.
Casey was the engineer on the Cannonball Express for the Midwest and Central Railroad. He had an extremely stressful job. Being taken hostage by mail robbers, fouling thieves in search of gold and repelling Apaches was all in a day’s work (though I can not remember him ever asking for a salary increase).
American railroads still distract me today. The system there is very different from the UK’s. Outside of the commuter districts of big cities, the main business of railways to transport cargo is not people.
The US has about 700 companies, but most are small (literally in the case of the real Midwest Central Railroad, which is a narrow-gauge heritage line). We have interests in two of the largest – Norfolk Southern and Union Pacific – each spanning more than 20 states, covering more than 30,000 miles of track and benefiting from the recovery in the U.S. domestic economy.
Union Pacific announced its third-quarter results last month, reporting operating revenues of $ 5.6 billion – up 13 percent. This is revenue before costs are taken into account. Rising fuel costs were an obstacle, but the company still managed to achieve an increase in operating income – profit after cost – of 20 percent. This is an example of a company that manages to pass on rising costs.
It is also one that finds ways to reduce costs. The best American railroads have consistently invested in technology over the past year. Today, high-tech precision scheduling enables railways to run longer, heavier trains – and to do so more safely. Union Pacific says it has increased its average maximum train length by 4 percent to 9,359 feet in the past year. Maybe you should read that sentence again. Yes, it works out at 1.77 miles long.
It may not please frustrated drivers who get stuck at level crossings and wait for them to pass, but longer trains help reduce the industry’s carbon footprint. Nearly half of all long-haul cargo in the U.S. is transported by rail, but it produces less than one-tenth of cargo-carbon emissions. Union Pacific and Norfolk Southern both say they are moving a ton of cargo 444 miles on a single gallon of diesel.
The industry continues to invest to improve its sustainability. To help the environment and protect investors from inflation. I’m sure Casey Jones would be happy to hear that.
Simon Edelsten is co-manager of the Mid Wynd International Investment Trust and the Artemis Global Select Fund