Stock Takes: Interest rates, inflation loom large for 2022

The prospect of higher interest rates and rising inflation is looming large on investors’ radar screens for 2022.

Annual inflation hit 4.9 per cent in the September year and the Reserve Bank has indicated that there will be steady increases in its official cash rate next year, rising from the current 0.75 per cent.

Wholesale interest rates have picked up sharply, particularly in the wake of Stats NZ’s latest inflation report.

Salt Funds managing director Matt Goodson says the key theme is clearly rising inflation, and central banks being dragged into ending quantitative easing and raising official rates.

“This has happened a touch earlier in New Zealand than some other countries and that is perhaps a reason why our equity market has underperformed in recent quarters after years of outperformance,” Goodson said.

“Equities aren’t necessarily a bad place to be when inflation and interest rates are rising – you just need to own companies that have pricing power and don’t get squeezed by either rising costs or rising interest rates,” Goodson says.

A key question for 2022 will be the fate of the housing sector, now that mortgage rates have risen sharply, he says.

Key industries

Jarden research analyst, wealth management, Tim Agar says the big concern is how long higher inflation will stick around.

“Most central banks around the world are still talking inflation up as being transitory, although a few of them are thinking that it might sustain itself for longer before peeling back,” he says.

“The longer that period is as we go into 2022, and as growth rates come off what have been quite robust levels in 2021, that might provide a challenging outlook for certain industries next year.”

However, Agar says that a number of industries tend to do well in terms of maintaining or even growing margins against an inflationary backdrop.

“In that group are the materials companies who supply commodities – they tend to benefit from price rises – because demand is robust, they push through price increases.”

Technology platform companies, whose customers tend to be quite “sticky” and for whom price increases are normally incremental, seem to be able to maintain margins as well, he says.

“Then you get those companies in the consumer staples space where the goods being purchased are needed and the price increases can be pushed through without losing the customer,” Agar says.

“When higher inflation is accompanied by strong economic growth, it doesn’t present as much of achallenge to companies, because rising costs can be offset by rising revenue driven by increasing volumes.”

Hence, the old saying that “a rising tide lifts all boats” – which has generally been the case so far in 2021.

“The critical moment is when growth slows while inflation remains elevated. Global economic growth is expected to remain robust in 2022, underpinned by the reopening of economies, although the rate of growth is expected to moderate from that seen in 2021.

“As a result, we expect pricing power to play a larger role for companies wishing to generate above market earnings growth in 2022.”

Electricity value

The share prices of the big power companies have been generally weaker this year, so are they now offering value once again?

In broker Forsyth Barr’s view, not yet.

“Whilst electricity share prices are generally down 10 per cent to 15 per cent since the end of May 2021, valuation metrics are still elevated and we still see downside risk for the sector,” Forsyth Barr said in a report.

“We have analysed sector valuations now versus December 2018 and conclude there is further downside risk.

“Whilst rising interest rates have led the sector lower, we think there is more to go.

“The lift in interest rates has partially had the expected effect on sector valuations.

“In addition, with interest rates rising, we expect investors forced into the equity market to find yield will retreat back to the fixed interest market (subject to supply), placing upward pressure on the spread.”

The broker’s growth forecasts indicate that after the 2024 full year, earnings growth is likely to be muted, with wholesale electricity prices likely to be materially lower than current levels.

NZ Bus sale?

Next Capital has mandated UBS to testpotential buyer appetite for its urban transport business NZ Bus, according to the Australian Financial Review.

NZ Bus is one of New Zealand’s largest bus companies, operating in Auckland, Tauranga and Wellington. It was once a subsidiary of Stagecoach Group and was later sold to Infratil, before being picked up by Next Capital in 2019.

The company has more than 700 buses across its 13 depots.

Sky's the limit

Sky Network TV’s share price shot higher after it upgraded its earnings forecasts.

The company said a cost-cutting exercise – which included clawing back money on its deal with NZ Rugby – had allowed it to boost its 2022 full-year profit guidance.

Jarden said Sky had also shown the first signs of all-important revenue stability.

Sky has lifted its 2022 Ebitda guidance from $115m-$130m to $150m-$160m.

“While Sky expects costs to be higher in 2022 than they were in 2021, the upgrade in guidance reflects the benefit of stabilising core revenues (potentially some Covid-related bring forward in streaming) as well as costs below previously budgeted levels,” Jarden said.

Season verdict

The November reporting season was slightly ahead of expectations, Forsyth Barr says.

Growth was boosted by industrial-type companies exceeding expectations, despite the dominance of property companies reporting results below expectations, it said. Beats and misses for the season were fairly balanced.

“Whilst our analysts have pulled back their estimates post result for 2022 and 2023, we note the number of positive outlook statements (albeit most were rated slightly positive) that have come through from the companies reporting during the season.”

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