Inflation reached its highest level in a decade last month. It currently stands at 4.2%, which is more than twice the Bank of England’s 2% target. Despite this, policymakers seem hesitant to adopt a more hawkish stance due to ongoing concerns relating to economic growth while the pandemic is yet to fully play out.
As such, buying shares in companies such as Unilever (LON: ULVR) and Imperial Brands (LON: IMB) could be a prudent move due to their capacity to pass higher input prices on to consumers. This may protect their profit margins and financial performance from the ill-effects of rampant price growth.
Unilever
Consumer goods company Unilever recently released a third quarter trading update that showed it increased prices by 4.1%. As such, it was able to report a 2.5% rise in underlying sales growth versus the same period of the previous year. It is also introducing productivity measures to further protect existing profit margins.
Further price increases could be ahead for the company’s customers. Unilever’s high degree of brand loyalty means that consumers may prefer to pay more for their favourite brands instead of trading down to cheaper generic options. This provides the firm with a relatively wide economic moat – especially since it has a diverse range of brands that reduces overall risk.
Meanwhile, e-commerce remains a strong growth area for the business. Online sales grew by 38% in the third quarter and now account for 12% of the firm’s total sales. They may further enhance customer loyalty due to the direct relationship Unilever has with online customers. They may also cut out retailers, thereby supporting margins in the long run.
Of course, Unilever’s share price has disappointed in recent months. It is down 10% over the past six months. Despite this, it continues to trade on a relatively high price-earnings ratio of 20. This is significantly higher than many FTSE 100 shares. But with its capacity to raise prices and annualised earnings per share growth of 9% forecast over the next two financial years, the company’s outlook could be positive.
Imperial Brands
Tobacco stock Imperial Brands may also be in a strong position to pass higher input costs on to consumers amid a period of elevated inflation. After all, cigarettes are relatively price inelastic. This means that demand is unlikely to fall significantly following even substantial price rises.
In addition, the firm’s recent full-year results suggest its refreshed management team is making progress in delivering on their strategy. For example, a simplified structure and investment in priority tobacco markets has led to a stabilising of the company’s market share. It is also piloting next-generation products such as heated tobacco after a mixed past performance in this area.
Unlike Unilever, Imperial Brands’ shares trade on a modest forward price-earnings multiple of around 7. However, the stock remains unpopular among investors – as evidenced by its 3% decline in the past six months.
This trend could continue due in part to the rising popularity of environmental, social and governance (ESG) concerns among investors that may limit demand for tobacco stocks. However, Imperial Brands’ capacity to overcome higher inflation, its sound strategy and wide margin of safety suggests its long-term risk/reward opportunity may be relatively favourable.