Key Takeaways
- Interest rate hikes and high inflation led to having an increasing impact on investment. Low consumer confidence and higher mortgage rates have hit the share prices of some companies.
- 4 core factors for selecting investment targets under high inflation
- 3 sectors and 3 Australian stocks Recommennded
1. Four key factors to consider when finding investment targets
Australian food price inflation rose to 5.9% in the second quarter of 2022, a 10-year record high; rising mortgage rates in Australia following the rate hike have affected banks' core business.
Hit by both inflation and interest rate hikes, consumer confidence fell for the ninth consecutive month, dropping back to its lowest level since August 2020
Under the current environment, there are four core factors that are key to identify the investment targets.
a. First and foremost: very strong pricing power.
To put it another way, a very unique competitive advantage or a very strong moat. Prices and profits of these companies are less susceptible to economic cycles.
The current environment means that the cost of everything is increasing because of inflation. But those companies that are able to pass on the costs to their own customers do not sacrifice the company's profits. Also those that do not have significantly fewer customers after a price increase. Such industries and companies must be the best performers at the time stage time point.
b. a healthy balance sheet
In the current specific environment, if the debt is too high, the company will be faced with great uncertainty. Then these companies are best avoided. In the current environment, investors should look at companies with healthier assets and liabilities and lower debt.
c. good revenue growth rate
d. a growth industry
The overall GDP growth rate has slowed down, but that doesn't mean that all industries are regressing. There are still industries that are in high growth. We can look for opportunities in these industries.
2. Under 4 factors, 3 Kinds of Industries Are Reliable
According to the 4 factors above, we sorted out 3 suitable industries.
a: the defensive industry.
A defensive industry can pass on the price increase cost to consumers. The most typical defensive sectors are infrastructure and healthcare.
b: Industries that are both defensive and growing.
Software companies that provide services to businesses are actually doing well. In other words, their stock prices may be affected by market sentiment, but the fundamentals of these companies are good. Then there is an opportunity for the industry to bottom out.
c: high-growth industries that are not affected by economic cycles.
ESG or new energy related industries. In addition, there are many other sectors such as further applications of AI, etc. or Industry 4.0, etc. The most obvious of the listed companies in Australia are probably the new energy-related mining industries.
3. Stocks that May Perform Well Under Rate hikes & Inflation
We are not saying that we have to invest in these companies, but a few more examples to better understand the basic idea of choosing investments in the current environment.
3.1 Defensive company - $CSL LIMITED(CSL.AU)$ , the leading Australian healthcare stock
CSL was once the largest Australian company by market cap, with its core business being plasma-related products.
Globally, CSL is also the leader in plasma products, with a market share of 80 to 90%. In addition to its technology, CSL's global blood collection sites and very high collection efficiency are also very important moats.
Its stock price had fallen significantly during the pandemic. The main reason was that the lockdown hampered plasma collection volumes and increased costs. But in the past year, the majority of developed countries have eased their pandemic control policies.Plasma collection has gradually resumed.
CSL's gross margins and ebitda margins have declined over the past fiscal year, in line with the plasma collection mentioned above. But the impact of the outbreak is largely over for CSL, so there will be a significant recovery to follow.
In fact, CSL's stock price has started to rebound somewhat. The valuation of CSL is still at a reasonable level, basically at the average level of the past few years.
Considering that the company holds the upstream resources of the industry chain, there is almost no competitor in its field, plus CSL has just recently made a strategic acquisition in Europe. The overall business in the next few years should be relatively confident.
If any short-term reasons make company's share price fall, it is a good opportunity to bottom out. Even under the pandemic and interest rate hike, CSL's overall stock price performance has proven to be a very defensive stock.
3.2 Defensive high-growth company - $Xero(XRO.AU)$ , an enterprise software services
Xero has a global presence, providing online accounting software to small and medium-sized businesses. In Australia, in particular, many companies now have xero as their accounting system.
Xero's defensiveness is reflected in the fact that xero is a necessity among all kinds of software used by companies. Xero has increased its price once. But I haven't heard of any company stopping using accounting software because of the rising price. It's a necessary expense for businesses. And xero is clearly a better performer than the others.
Xero has a very good revenue growth rate. The company's recenue and gross margins are growing in the current economic headwinds; revenues are still growing at a very healthy rate. Xero offers software services with limited costs and high gross margins over the long term.
Xero was oversold during the tech stock crash. This means that the company's share price is currently significantly below the average valuation of the past few years.
Xero is in a growth industry. The fact is that digitalization on the enterprise side is significantly lagging behind that of the individual. So there is still huge room for growth in enterprise digitalization.
Of course there is more than one software or technology company in the enterprise services category. We should pay attention to the following points when looking for the leading companies in these industries in the current environment: the company's volume is large and is not at risk of bankruptcy or serious financial problems due to the economic environment.
3.3 High growth industry - new energy lithium $Pilbara Minerals Ltd(PLS.AU)$
In Australia, the market that benefits most directly from new energy is the mining industry. Australia ranks very highly in global lithium reserves and production.
Pilbara Minerals is one of the largest listed lithium mining companies in Australia and wholly owns Pilgangoora, the world's largest independent hard rock lithium project located in Western Australia.
The lithium market is a high growth industry. Currently, it is still really in short supply, and the growth rate of all kinds of electric vehicles is very rapid. In particular, the recent energy crisis has created a particularly large opportunity for electric vehicles. In Australia, many in the private sector have taken the initiative to make higher ESG requirements for themselves. The new energy direction is the future.
Lithium pyroxene prices jumped 408% from early 2021. This has been the main reason for PLS's explosive performance, contributing over A$1 billion in revenue and driving the share price skyrocketing. We can see that its revenue growth has doubled tenfold and ebitda's margin is as high as 70%.
So one might wonder: is the company too expensive or is the latest pricing reasonable? In the second quarter of this year, some of the big and famous investment banks were bearish. But whether it's overvalued or not requires financial models to determine. But the general direction has not changed.
But in fact, if you look at the direction of the whole industry, the demand for lithium is still very large.
Summary
Consumer confidence is relatively low and economic growth is slowing down in a hyperinflationary environment. In this environment, four sectors are facing challenges: consumer discretionary, banks, iron ore and, natural gas (transportation and inventory issues).
In this environment, we also suggest some directions to focus on:
- Defensive sectors such as infrastructure or utility related - $CSL LIMITED(CSL.AU)$
- Defensive and high-growth enterprise services software companies - $Xero(XRO.AU)$
- High growth industry - future direction of new energy $Pilbara Minerals Ltd(PLS.AU)$
Many investors don't realize that it's a mistake to simply lump all companies or technology companies into one category. Companies like $Xero(XRO.AU)$ have completely different business models with $Meta Platforms, Inc.(META)$ .
Finally, there are some high-growth sectors that still have enough momentum to grow in the current environment, such as ESG and new energy.
One thing to watch in the Australian stock market is lithium mining companies. You can also look at some of the new energy surrounding facilities industry, I believe in the next few years will be more and more.
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