Soaring energy prices, fuel costs and food bills have released the inflation genie from the bottle once more, with the UK’s Consumer Prices Index (CPI) measure rising to 9% over the 12 months to April 2022, the highest rate for 40 years.
Inflation can present a significant headwind for companies, which is why its return has contributed to significant market volatility. Rising wage bills and other input costs can erode earnings and rampant inflation also dampens confidence among consumers and businesses, causing them to rein in spending.
However, one of the characteristics we look for in companies is ‘pricing power’. This is where a business can increase prices to pass on rising costs to its customers, without a significant loss of trade. This should help such companies successfully navigate periods of higher inflation and continue to grow their earnings.
Safestore
We hold Safestore, which is the UK’s largest provider of self-storage facilities and the second biggest in Europe.
The company caters for businesses and individuals and has performed strongly through changing business environments. Companies need extra storage space both when they are upsizing and when they are downsizing – and people continue to move home and need storage throughout the economic cycle.
Crucially, Safestore has demonstrated robust pricing power, enabling it to edge up prices to more than offset inflation. In a trading update in February, the company said the average rate it charged for storage in the three months to the end of January 2022 was just over 13% higher than in the same period a year earlier.
This pricing power, combined with healthy occupancy levels of 80-90% and a very respectable return on capital, means Safestore is a strong, resilient business, well positioned to navigate a period of heightened inflation and emerge stronger than ever.
Diageo
Global drinks giant Diageo is another company we hold with strong pricing power, underpinned by the popularity of brands such as Guinness, Johnnie Walker and Smirnoff. The company has successfully raised prices over the past year, helping to ensure continuing revenue growth, while also increasing market share.
Diageo reported in January that price increases, together with improved productivity, had more than outweighed the impact of cost inflation over the previous six months. The company has, for example, increased the price of draught beer sold to pubs and other venues in Ireland by 6%.
The business is benefiting from drinkers’ increasing appetite for spirits and, as the ranks of the middle classes grow around the world, a shift to premium brands. In addition, more and more drinkers are moving up from Diageo’s premium brands to its luxury ‘reserve’ products, such as Johnnie Walker Blue Label whisky.
This is a resilient business with strong brands and a global footprint. We like its pricing power and the strategy of increasing sales of higher-priced premium brands.
Watches of Switzerland
We also hold Watches of Switzerland, which is the leading luxury watch specialist in the UK, selling brands including Rolex, Omega and Patek Philippe. The average price of a watch sold is around £6,000. This luxury market positioning and the fact that demand for many of these watches substantially outstrips supply gives Watches of Switzerland significant pricing power, which it has used successfully to offset rising costs.
It is not though merely content with outpacing rising costs. The company has a robust growth strategy, using its strong brand and online presence to gain market share. Watches of Switzerland has ambitious plans for growth in the US, which currently generates around 40% of profits, and we believe there is scope for significant further expansion.
The company uses strong cashflows to finance both organic growth and acquisitions and achieves a very healthy rate of return on capital invested. We believe the resilient business model and strong pricing power mean it is well positioned to weather a period of heightened inflation and continue to successfully implement its international growth strategy.
The unexpected surge in inflation has shown just how difficult it is to accurately predict what lies ahead. This underlines the value of investing in quality businesses like Safestore, Diageo and Watches of Switzerland, which we believe can continue to grow successfully despite a more challenging economic backdrop.
Richard Hallett is manager of the IFSL Marlborough Multi-Cap Growth fund. The views expressed above should not be taken as investment advice.