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3 retail shares to help weather inflation

A closer look at 3 retail shares we think could withstand and prosper through the inflation squeeze.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

All information is correct as at 30 April 2022 unless otherwise stated.

UK retail sales declined in just about every category in March, as people battened down the hatches for what’s expected to be the largest cost of living squeeze in almost 50 years.

While it’s clear retail stocks are in for a bumpy ride, it’s important not to throw the baby out with the bath water. Not all retail behaves the same in periods of inflation. It’s worth looking at which parts of the sector have the potential to withstand, and prosper in current conditions.

Investing in individual companies isn’t right for everyone – it’s higher risk than investing in funds as your investment is dependent on the fate of that company. If the company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Costco – doubling down on discount

Discount retailers balance on a knife edge when inflation rises because they rely on volume to turn a profit.

On the one hand, they’re the recipient of new customers as people slide down the value chain looking for cheaper alternatives. But their customers also tend to be some of the most price-sensitive, so passing on increasing input costs can put a dent in volumes.

Costco has nestled itself in a sweet spot among discount retailers. Profits are driven by recurring membership fees. That means sales margins aren’t as sensitive and the group can afford to sell merchandise with a lower markup than some of its peers.

This ‘pricing authority’ is what keeps members coming back – they trust that Costco will have the lowest price.

Lower priced petrol sales are another big draw, particularly in the current environment. Normally, this would really hurt margins for a discount retailer, but since Costco’s bread and butter is membership fees, competing on price isn’t such an issue.

Costco global membership renewal rates

Scroll across to see the full chart.

Source: Costco annual reports.

This value proposition means renewal rates are high – 90% across the globe at last check (not a yearly figure like the chart above). This steady, predictable income kept free cash flow beyond $5bn throughout the pandemic.

It’s also helped the group maintain a growing net cash position that’s been over $2bn for the past three years. This financial fortitude allowed Costco to reward shareholders with special dividends and share repurchases in 2021, despite rising inflation worries. Remember though, no dividend is ever guaranteed.

Costco’s business model is unique and admirable, but it doesn’t come without chinks in its armour.

The group’s largely avoided the shift online, with only 7% of 2021 sales coming from e-commerce. So far, this hasn’t been an issue with customers willing to visit the warehouses to see what bargains are on offer. But as the convenience of online shopping continues to gain momentum, it’s something investors will need to keep in mind looking to the very long term.

More important in our view is Costco’s valuation. Shares change hands for more than 38 times forecast profits, well beyond its long-term average. That increases the risk of near-term volatility as expectations are high.

Costco’s unlikely to get through the next year without ups and downs – rising gas prices will take a toll on profitability. In our view, Costco’s long-term attributes are intact, but investors are having to pay for that strength.

View the latest Costco share price and how to deal

A connected party of the author holds shares in Costco.

LVMH – leapfrogging consumer malaise with luxury

High-net worth customers should make luxury retailers a good place to be in inflationary headwinds.

It’s no secret that the millionaires buying high-ticket handbags aren’t as worried about rising fuel and food prices. But simply catering to the wealthiest among us isn’t enough by itself to make luxury retailers a worthy consideration. Strong brand power, deft management, and a unique operating model are all important factors to think about.

LVMH fits this criteria. The group’s made up of several strong brands ranging from jewellery, accessories and clothing, to cosmetics and even wine and spirits.

LVMH revenue (%)

Source: LVMH 2021 annual report.

Fashion and Leather Goods is the group’s largest division, making up roughly half of overall revenue. It includes well-known and respected brands like Louis Vuitton, Christian Dior and Marc Jacobs.

Growth in this segment has been heady in the wake of the pandemic, with sales adjusted for exchange rates up nearly 30% in the first quarter. This should feed through to profits nicely, with operating margins in this segment over 40% last year.

Strength here has offset a decline in Wines and Spirits, where sales rose just 2%. The sluggish growth is due to supply chain issues which will hopefully resolve as we exit the pandemic.

The group also benefits from geographic diversity. Asia is the group’s largest market, bringing in just over a third of total revenue last year. That’s followed by the US and Europe, making up 26% and 15% respectively.

That’s not to say it’s smooth sailing ahead though.

LVMH’s reliance on China means the continued pandemic restrictions have weighed on investor sentiment. Uncertainty about what’s next regarding lockdowns, is a risk to performance moving forward.

The group’s also dragging around a sizable debt obligation following its acquisition of jewellery giant Tiffany’s, with net debt upwards of €14bn.

Repaying debt will likely be a priority for the next few years, but it isn’t unmanageable.

These risks have brought the group’s valuation down significantly over the past year to a touch under 22 times expected earnings. Though it’s still trading slightly higher than the long-term average.

View the latest LVMH share price and how to deal

Register for updates on LVMH

Reckitt Benckiser – well-known essentials to weather inflation

Brand power is a major strength when prices are rising. Its hold has been somewhat eroded as supermarket own-brands worm their way into consumers’ hearts. But consumer goods company Reckitt Benckiser makes the kinds of products that still benefit from brand cachet.

The group makes pandemic staples Lysol and Dettol. As restrictions fade, there are some things that will stick around, and heightened awareness for cleanliness is one of them.

That’s been working in Reckitt’s favour. Demand for these products has come down somewhat from 2020 highs, but appears to be rebasing at a new, higher level than before the pandemic. With germs at the forefront of the public's mind, giving up their favoured cleaning products to save a few pennies is probably bottom of the list for most consumers.

Hygiene revenue (£bn)

Source: Refinitiv.

Corporate partnerships underscore the power of a strong name. British Airways has started handing out Dettol branded wipes to customers to ease worries about the spread of disease on flights. This puts the brand in front of a lot more eyeballs.

On top of churning out new products, Reckitt’s also growing its online business, an expensive endeavour. Add to that rising inflation, and the demands on cash are not insignificant. It will be important for the group to continue paying down its debt as well, with net debt sitting slightly higher than we’d like.

The group’s recently increased its focus on the most promising growth avenues, a strategy that should work in its favour as we head into a more difficult environment. Despite rising cost pressures, underlying operating margins of 22.9% are expected to keep growing.

Shares trade broadly in line with their long-term average of 20 times earnings, suggesting the market’s aware of Reckitt’s stronger position in these challenging times.

Reckitt also comes with a 3% prospective dividend yield, which makes the potential for near-term volatility more palatable. Remember though, no dividend is ever guaranteed.

View the latest Reckitt Benckiser share price and how to deal

Register for updates on Reckitt Benckiser

This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to future returns.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.

Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure on our website for more information.


Explore our Investment Times spring 2022 edition for more articles like this.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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