Friday Morning Coffee Nr 148 - Some beneficiaries of rising input prices

Production costs have been rising steadily over the last months with increasing commodity and transport prices. The price of copper and iron ore are up more than 80% in USD over the last 12 months. Brent crude future is up 207% over the same period. Freight costs on the China-Europe route have soared: the weekly container spot rates out of China (SFCI) is up 242% over 1 year. 

Rising commodity prices leading to lower profit margins is the simple top-down assessment. In this case, this view may be too simplistic as the impact on corporate earnings is different by sector and by company. It largely depends on whether the companies can pass through the rising costs to its clients, the market position of the companies and of course the industry we look at. To illustrate our point, we choose in our European portfolio three examples on companies we think are dealing well or even benefitting from this environment:

1)     A Price maker who passes on part of the higher input prices to their customers: Husqvarna

The producer of robotic lawn movers and watering equipment (Gardena) came out with Q1 numbers this week showing again a strong start into the year. Organic growth was a stunning 24% and the operating margin increased by 460 bps to 16.3% during the quarter. As the company states in its press release this is due to “continued favourable product mix, combined with good cost control … despite higher costs for raw materials and logistics.”. Husqvarna is a good example on how the right products, tight cost control and powerful brands (Husqvarna, Gardena, Stihl, …) help preserving profitability when input prices rise.

2)     A key beneficiary of increased CAPEX to address the shortage in semiconductors: ASML

The biggest industrial clients for semiconductors (for example the car industry) are now paying a hefty price for having reduced their inventories and taking out as much costs as possible of the supply chain. As we come out of the pandemic and business activity restarts, they are missing crucial parts of equipment for their products. The result of this shortage are price increases and soaring demand. ASML is the global market leader in supplying lithography systems to the semiconductor manufacturing industry, with over 80% market share. The company is expected to reach more than 20 bn EUR in sales next year and has an operating margin of 33%.

3)     The market leaders in the transport industry: Hapag Lloyd

We believe there is more to the rising freight rates than the Covid-19 consumer demand and the blocking of the Suez Channel. Indeed, the industry has been consolidating by forming global alliances and has become more disciplined in adding new capacity (ships). Hapag benefits from these trends being the 5th largest container shipping operator worldwide operating 230 vessels. The company is now yielding the benefits: consensus expects the company to earn 2.5 bn EUR in net profits this year compared to a market cap of 25.5 bn EUR. We started to invest in Hapag Lloyd in November 2020.

  1 year stock price performance of Husqvarna, ASML and Hapag Lloyd

source: Bloomberg

The three companies represent 5.4% of our European Value Portfolio. It is not a surprise that they significantly contributed to overall portfolio performance over the past year. It again shows that value investing is more than about buying into low margin cyclical industries at depressed P/BV. It is all about undervalued earning power.

I wish you a nice weekend,

Léon

Important notice: This document is published for information purposes only and gives the opinion of the author at the time of the publication. It does not constitute an offer to buy or sell financial instruments or investment advice and does not confirm any transaction unless expressly agreed otherwise.