3 shares that could thrive in a recession

Predictions of recessions have spooked markets recently. That’s because, for lots of companies, performance is closely linked to a growing economy. However, that doesn’t mean it’s time to panic.

There’s no question that a recession makes it more difficult to perform well. But it also tends to allow the cream to rise to the top. That’s why understanding the companies you invest in is more important than ever.

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Not all companies are created equally, some are in a strong position to not only survive, but could thrive, in a recessionary environment. Here are three shares we think have potential to prosper.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a 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.

Wise – global payments disruptor

Formerly known as Transferwise, Wise made its debut in London almost exactly a year ago and is one of the UK’s few tech stocks.

Since then, shares have been on a somewhat steady decline as excitement over the IPO faded and market conditions got worse. Lots of this was down to valuation – at its peak, shares changed hands for more than 150 times expected earnings. But over the past year we’ve seen the share price settle and we think that warrants another look.

Wise is a financial technology company working to disrupt the market for cross-border payments. This is a strong position to be in given the value of cross border payments is expected to rise to $250tn by 2027. Wise was responsible for $54bn worth of transfers in 2021, leaving the door open for potential growth ahead if the group’s able to capture market share.

Sending money across the globe is nothing new. But Wise aims to make this process easier and cheaper by allowing one person to generate local payment details and hold multiple currencies all in one account. The idea is that they’ll avoid hefty fees often charged by big banks.

So why now? Apart from the fact that Wise shares have made their way down to a more reasonable valuation, there’s the growth factor. Global payments revenues are expected to grow by 6-7% per year, that makes companies operating in this industry look attractive given global economic growth is expected to decline 3.3% over the medium term.

Wise Revenue (£m)

Source: Wise 2021 Prospectus and Refinitiv 06/06/2022, *yellow bars are estimates and are therefore not guaranteed.

Wise is targeting revenue growth of around 30% this year. And with the group continuing to steal market share, the market sees the top line growing over 20% for the next few years to come.

Meanwhile, gross profit margins should remain above 60%, despite Wise’s decision to lower prices. That reflects the group’s ability to offset price decreases with volume increases. The cheaper it is for people to use the service, the more people Wise should be able to sign up.

Profit growth has translated handily into improved free cash flow generation, with £59m rolling through the business and the group’s also sporting a net cash position. All this puts it in a strong spot heading into a period of economic volatility.

Wise isn’t immune to a widespread pullback in spending though. And, although the valuation has come down significantly, at 39 times forecast earnings, expectations are still lofty. That makes near-term volatility more likely as economic worries continue to weigh.

View the latest WISE share price and how to deal

Microsoft – finding value in tech

Rising interest rates and the threat of more rate hikes has the tech sector on pins and needles. The sky-high valuations the sector’s become known for are starting to crumble as investors demand more from their investments. But as we head into a period of belt tightening among many of the world’s businesses, there are two hallmarks of a successful business.

The first is one that offers essential services that clients simply can’t live without. The second is helping clients to do more with less.

We think Microsoft fits squarely into both of these buckets. The group’s suite of office products are a mainstay in the corporate world and now that they’ve been transformed into service offerings delivered via the cloud, they’re more affordable. Not to mention they give Microsoft a recurring, reliable source of revenue.

Azure, the group’s cloud platform, has grown to make up just under 40% of overall profit, a testament to the group’s ability to shape-shift alongside a changing environment.

Microsoft Revenue and Profit Breakdown ($m)

Source: Microsoft 2021 Annual Report.

We’re seeing the beginnings of yet another rebirth at Microsoft, with Activision Blizzard set to join the portfolio to round out the group’s gaming portfolio. The size of this part of the business is currently just a drop in the bucket. But there’s plenty of room to run. The gaming market’s expected to more than double between 2021 and 2028.

The group’s resilient portfolio of businesses isn’t the only reason Microsoft could held up well in a recession.

The group’s also sitting on an iron-clad balance sheet, sporting a net cash position in excess of $70bn, which has allowed it to go after strategic acquisitions like Activision Blizzard. That’s thanks to careful capital management and generous free cash flows.

The group’s valuation, although still some way above the long-term average, is at its lowest level since March 2020. That’s thanks to the tech sell off amid interest-rate hikes. Short-term volatility is to be expected, particularly with more economic pain ahead. We think Microsoft’s been caught in the crosshairs and the selloffs could be considered an attractive entry point. But Microsoft isn’t immune to the challenging macroeconomic backdrop and we probably haven’t seen the last of the turbulence for the wider tech sector.

View the latest Microsoft share price and how to deal

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Ibstock – bridging the housing gap

Construction doesn’t tend to hold up well in times of recession. Less money floating around means it’s harder to justify the cost of new buildings. That makes for a difficult environment for companies reliant on these kinds of projects.

However, brick-maker Ibstock is well positioned to thrive even if the economy starts to sour. And its valuation, currently below the long-term average, suggests the market could be overlooking its strength.

The group’s benefited as post-pandemic demand returns, but the longer-term picture looks relatively rosy despite the wider uncertainty.

As a materials-maker, Ibstock gets paid no matter where house prices head. A hot market means there’s more room for Ibstock to pass on rising input costs. But ultimately, brick and concrete will be in demand as long as new houses are needed. Needed is an understatement in the UK.

Supply of new houses in England

Source: Government Housing Department data.

To meet demand in the UK, the National Housing Federation says 340,000 new homes need to be supplied each year. The government is aiming for 300,000 annually. In 2021, 216,489 were supplied. That suggests new construction will be a priority for years to come.

Apart from servicing that demand, Ibstock’s also setting itself up to become a primary player in affordable, sustainable housebuilding with the advent of Ibstock Futures.

This part of the business is small but mighty, boasting environmentally friendly brick facades and glass reinforced concrete. It’s expected to boost underlying cash profits by £10m per year once up and running. That’s about a 10% uplift on this year’s profits. But it also cements Ibstock’s position as an eco-friendly supplier. Plus, the materials housed in this division are cheaper to build with, making them a win-win for builders.

It will take time and money for Futures to get off the ground. The brick slips won’t yield any returns until 2025, when the factory’s running at capacity.

With a 4.8% prospective dividend on offer and a new division to build out, the demands on cash are not insignificant. That could create some near-term volatility, particularly if wider economic conditions worsen. But for investors that can stomach some turbulence, the longer-term picture looks promising.

This article isn’t personal advice. If you’re not sure if an investment’s right for you, seek advice. Remember, yields are variable and not guaranteed.

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The author holds shares in Ibstock.

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 for more information.

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