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What European inflation concerns and supply chain disruptions mean for investors

September 29, 2021

Supply chain issues and inflation concerns are affecting European equities ahead of the Q3 earnings season. Paul Wild explains the opportunities and risks

  • Companies with pricing power will endure inflation best
  • Products and parts shortages causing price pressures
  • Earnings risk for many European companies

INFLATION and the pricing power of companies are emerging as key determinants of the earnings outlook for European corporates, as the third quarter ends and central banks take steps to address rising inflation.

The September quarter earnings season in Europe is still two weeks away, but already the theme of product and parts shortages has emerged among big corporates. And that’s led to investor concern about inflationary impacts on profit margins.

Inflation — be it transitory or structural — is being felt across the region and the recent shift by global central banks away from ultra-loose monetary policy is adding to fears that rising prices are more than just temporary.

“It’s clearly a good time to look for stocks that have strong pricing power, and the German car makers are an example of that,” says Paul Wild, senior fund manager at Pendal Group’s UK-based asset manager J O Hambro Capital Management. “Or simply look for service companies that are relatively immune, not least the banks.”

The type of inflation he is talking about is related to delays and supply chain challenges, which have affected many industries across Europe.

“Heading into the third quarter, there’s definitely a little bit more earnings risks for markets,” Wild says.

European markets have performed well in 2021, with the STOXX Europe 600 – a measure of the largest companies in the region – up 14 per cent so far this year. But the index is down 4 per cent over the past month. It’s underperformed the S&P500 over both time periods, notwithstanding the outlook for recovery in Europe is strong.

Much of that comes down to the supply chain issues.

Pendal wins Fund Manager of the Year 2020

“The loss of capacity of semi-conductor chip production in Malaysia is hitting the automobile companies, for example,” Wild says.

“But so too is a slowdown in manufacturing in Vietnam, where 40 per cent of Adidas shoes are made.” The unifying factors are continuing lockdowns amid low vaccination rates in these countries.

Global shipping delays and costs are adding to price pressures.

“The supply chain issues are exacerbated by port delays, particularly in China and the west coast of the United States.

“And then you have internal trucking costs which have become more scarce and increasingly expensive. The question is how long will all these things last?”

Look for European strong pricing power

Wild says investors should look towards companies that have strong pricing power and sell products that people will wait to buy.

Again, he points to German auto makers which are rapidly increasing their range of sought-after electric vehicles.

“New car prices in some examples are going up by over 10 per cent — driven by the rising steel cost burden — and that’s having an impact on second-hand car prices. Global production levels are running at about 10 per cent below 2019 levels.”

Wild says investors should consider whether delays in the supply of some products will defer demand or destroy it.

Otherwise look for companies that are relatively unaffected by supply chain and manufacturing disruptions on the other side of the world.

“That’s the service sector. Banks look perfectly placed in the current environments, inflation beneficiaries with relative insulation within their own cost base.”


About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Pendal offers a range of global equities strategies to Australian investors including:

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here.


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