2Q 2022 European Equity Outlook: Preparing for the unexpected with quality companies

Preparing for the unexpected with quality companies

Portfolio Manager Donny Kranson explores the impact of war and the energy crisis on consumer confidence in Europe, managing inflation and companies that are adjusting quickly to change.

• Pandemics and war are difficult to foresee, but investors should always expect the unexpected. Investing in quality companies with low leverage and that sell essential products can protect against negative surprises.
• Consumer staples companies with better brands, differentiated products and strong innovation have started to pass on price increases to consumers. Even private label prices are increasing. Eventually increased costs will be fully passed on. Pricing for quality companies tends to go up during periods of inflation but does not reverse when inflation cools.
• There has been a divergence between companies able to adjust quickly to a changing environment and manage supply chains, and those that cannot. Low unemployment means consumers have more money and are open to new products, which tend to have higher prices and margins. However, affordability is important too and companies need to innovate with brands at lower price points.
• Companies with high gross margins do not need to raise prices by much to offset inflation, and some luxury goods companies have customers that are able to absorb higher prices. Essential industries, such as pest control or data and technology services, also have strong pricing power.
• Europe is working on increasing access to alternative energy sources, but the shift will take time and there is talk of gas rationing in Germany. Even with a peaceful outcome to war in Ukraine, Europe will not want to be as reliant on Russian energy in the future.
• War and the energy crisis have also hit consumer confidence in Europe. On the plus side, countries are spending more on green energy, the military, and responses for refugees, while some governments have announced support for energy bills. There is also increasing demand among consumers after COVID shutdowns, such as in strong summer travel bookings.
• Due to social media, companies must adjust quickly or be shamed. Consumers and investors know they have a voice and can push companies to do what they believe is right. The speed at which companies are making changes is not surprising.
• Conflict in Ukraine has unintentionally brought Europe closer together. Disputes between Poland and Hungary and Brussels have been pushed to one side and European nations are presenting a united front for now.
• Sources of volatility are plain to see, including the continuing effect of COVID, war and high inflation. Manufacturers may also struggle to access energy at any price. Central banks have a tough job to manage inflation without causing a recession. Investors should look for companies with strong balance sheets, steady growth, and that trade at sensible valuations to position for an environment with increased uncertainty.

 

 

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