What are some of the beneficiaries of inflationary environments?
Almost any set of economic conditions – including inflationary environments – are going to produce at least some winners. Who is poised to benefit from the inflation we’re seeing now?
To determine what businesses might benefit from inflation, we need to ask what kind of inflation we’re talking about.
The inflationary environment of the 1970s, for example, was very different from what we have today. Then, we had an economy heavily based on fossil fuels with a lot of tension with the Organization of the Petroleum Exporting Countries (OPEC), which played a large and concentrated role in setting market prices for oil.
A lot of that has changed. Our economy also isn't as industrial as it was. Back then, the beneficiaries were typically organizations leveraged to higher commodity prices in a direct way.
But those classic inflation beneficiaries may not benefit as much from the inflation we’re seeing today. Right now, I would kind of adhere to a Warren Buffett type perspective. Businesses that can raise revenue faster than cost are the businesses you want to own.
In other words, if you can find businesses that have the pricing power to outpace inflation, it leads you to almost the opposite type of business from those leveraged to commodity prices. Today, that would mean the type of assets that have made all of their investments up front and have built a toll road that requires minimal maintenance. These are businesses that don't require a lot of employees, overhead, or capex per dollar of revenue. A business that’s insulated from inflation is going to benefit relative to the rest of the world.
To identify those companies, it’s necessary break apart the financials to see how certain companies make their money and what is required to maintain that level of revenue. For instance, a high operating margin suggests there's some moat there, which in term doesn't require a lot of investment. These kinds of companies require almost nothing to maintain revenue; they can grow with little additional cost, and that gives them an ability to play offense in an environment in which others might struggle.
Costco, for example, has a fairly low-cost producer model. It makes most of money off membership fees, and its Net Promoter Score is extremely high relative to competitors. They're in a strong position because of goodwill they've built with customers, and they've spent years and years re-investing every dime of efficiency back to customers in form of lower prices, so they're in a position to succeed if prices go up.
Similarly, Big Pharma is fairly well positioned for an inflationary environment. Deserved or not, they enjoy a lot of protections, exclusivity, and if they can extend R&D already completed (so they're more in payback phase), they'd do just fine.
By contrast, some businesses require a huge of amount of capex just to maintain. Those companies are going to be more sensitive to higher interest rates. I don't want to own asset intensive businesses that have to continuously reinvest cash flow in things that are costing them more and more just to stay competitive. I also wouldn't want to be someone who has a lot of debt that's poorly structured, e.g., debt based off of LIBOR (the benchmark interest rate traditionally used to set short-term interest rates).
At the end of the day, it always comes back to the same thing: I don't want to own a bad business, and good, well-run businesses are always going to be a better bet in an inflationary environment.