3 share ideas to ride out a recession

While the UK managed to narrowly avoid a recession in January, many, including the Bank of England, still think one could be on the cards in 2023.

Better than expected economic data out last week has once again called this into question though. February saw a strong rebound in business activity within the UK services sector, raising our hopes of avoiding a recession for now – but is this it, or could we see a recession, and if we do, how deep will it be?

Recessions and the stock market

During recessions, stocks have tended to fall as businesses struggle and consumer spending slows down. This can be painful for even the most diversified portfolios.

However, not all companies are created equal when it comes to weathering recessions. Some businesses are more ‘recession-proof’ than others, meaning they have tended to hold up better during tough economic times. They typically offer investors some ‘shelter’ when the economy enters a downturn.

Investors looking to build a resilient portfolio could consider investing in companies whose fortunes aren’t directly tied to the health of the economy – companies that have potential to make money come rain or shine

Here are three companies that fit that bill and might be able to come out of a recessionary storm relatively unscathed. Perhaps even benefiting as competitors struggle although of course there are no guarantees.

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 is not a guide to the future.

Remember, investing in individual companies isn't right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

ASML

Based in the Netherlands, ASML is a market leader in the design and manufacture of lithography machines used to make semiconductor chips. Without these machines, you wouldn’t have the chips that power the latest phones, computers or even cars.

ASML is the sole producer of the most advanced type of lithography machines, called Extreme Ultraviolet (EUV) lithography. It took ASML over 20 years to research, develop and commercialise the technology involved in EUV – which is now a near impossible moat for any competitor to try and breach.

Besides the EUV machines, ASML also captures the majority of the Deep Ultraviolet (DUV) lithography market. DUV tools are used for less sophisticated chip production, but still play an important role in everyday technology.

Being the sole supplier of EUV machines has its perks. ASML’s €40.4bn system sales backlog far exceeds its 2022 revenue of €21.2bn. Management expect 2023 sales to grow by more than 25% because of this. This makes revenues more predictable, which helps prop up prices and margins, allowing the company to focus on innovation.

There’s also the services side of things, a recurring revenue stream which makes up around a quarter of annual sales. This includes upgrading or fixing the machine. The more machines sold, the more recurring revenue streams ASML receives, making that portion of revenue extremely robust.

But it’s not all blue skies. Potential stumbling blocks lie in the sheer logistical task it takes to assemble an EUV machine, which comprises of over 100,000 different parts. Not having just one part could cause bottlenecks in the manufacturing process, hampering timelines and potentially hurting profits.

ASML’s market position and order book means it has strong earning power, even in the face of a recession. But this is accounted for in the group’s valuation – it trades well above its long-term average. While the price could be justified if targets are hit, there’s a lot of expectation on its shoulders. Failing to deliver could punish the valuation.

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BAE

When you think of recession-shelters, you’re often looking for a business whose revenues are capable of holding up even as consumer spending pulls back. Given BAE is in the defence business, we think it fits the bill.

The group primarily manufactures and delivers heavy duty military equipment – think fighter jets and aircraft carriers. Its customers are governments whose budgets don’t face quite the same pressures as the general public.

BAE’s using some of its financial firepower to accelerate research and development in a bid to improve its portfolio – this is a smart move. Companies which invest now are more likely to reap the benefits in the future, as countries try and keep their defence systems up to date.

Undoubtedly, recent global events have had positive effects on BAE’s growth over the past year, but no one quite knows how long conflicts will last. That’s why the order book is so important.

Record order intakes in 2022 mean order books are currently sitting at a formidable £59bn. And as these are predominantly long cycle, with revenues spread over several years, it gives BAE multi-year revenue visibility. An enviable asset to have in uncertain times.

But ultimately, the group’s profitability is based on estimates of revenues and costs. The long-term nature of many of its contracts means that related risks and costs can change over time. Currently, it’s rising energy costs and supply chain issues that are causing some turbulence for the fighter-jet maker.

BAE’s in good shape to deliver on its long-term growth strategy and the market appears to agree – BAE is trading at a valuation some way above its long-term average. This could increase the risk of ups and downs.

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Coca-Cola

Coca-Cola’s a company that needs very little introduction. Having been around for more than a century, it’s gone through a few recessions in its time.

Strong brand power is arguably Coca-Cola’s biggest asset. It’s allowed the group to raise prices without denting volumes sold, as loyal customers just can’t get enough of the group’s infamous fizzy drinks – including household favourites like Coca-Cola, Fanta, and Sprite.

These price hikes were the main factor driving organic revenue growth of 15% to $10.1bn in the fourth quarter of 2022.

A key thing differentiating Coca-Cola from most other drinks makers is its operating model. Rather than investing in big manufacturing plants, Coca-Cola partners with, and holds stakes in, local bottling companies in what's known as the Coca-Cola System. That allows the group to keep costs down and supports its industry leading gross margins, which have hovered around the 60% mark.

During tough economic times, consumers might cut back on non-essential purchases. However, the group’s vast array of beverages are seen as an affordable luxury that people are willing to indulge in even as they tighten their belts.

But the beverage giant isn’t without challenges.

Consumers are becoming increasingly health-conscious, and this trend has led to a decline in demand for sugary drinks. While this is certainly an area to keep an eye on, it’s not a major concern just yet as the group has other lower-sugar alternatives which are selling well.

Moves into the hot beverage and sports drinks markets, with acquisitions of Costa and BODYARMOR respectively, have also lifted the lid on new growth channels.

If inflation continues to put pressure on Coca-Cola in 2023, the group should be able to keep passing higher costs straight onto consumers in the form of more price hikes. But the market is currently putting a slight premium on this benefit as the group trades just ahead of its long-term valuation.

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Estimates aren’t a reliable indicator of future performance. 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 for more information.

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