The prospect of chronic post-COVID inflation dominated discussion and behaviour in share markets for months earlier this year.
But now that the nasty delta variant of the virus is ravaging Australia, there is very little talk or anxiety about it. The Reserve Bank even hinted this month that the resurgence of the pandemic could force it to extend support rather than withdraw it.
One expert warns though that “anyone feeling sceptical about inflation would be wise to tune in to the final week of the August reporting season”.
“If the first 3 weeks are any guide, inflation is no longer on the horizon,” said Yarra Capital Management head of Australian equities Dion Hershan.
ASX reporting season shows inflation not temporary
According to Hershan, it was easy enough to label the current inflation as ‘transitory’ when it popped up in a few specific products like timber and airfreight.
“But company results confirm just how far-reaching it appears to have become,” he said in a memo to clients.
“This has significant implications for rates and the margins of public companies. As one company reprices to recover input cost inflation, it can become self-perpetuating.”
Hershan is nervous that the market is not aware of this.
“Our strong sense is most investors are either complacent or dismissive of the issue, and only when they start to see margins and earnings decline will the issue come into sharper focus,” he said.
“Although COVID and lockdowns — quite rightly — dominate headlines and short-term thinking, inflation and the consequent margin pressure it can create will be an important issue in the years ahead.”
Some signs of chronic cost rises
Hershan cited some examples that tipped him off to the likelihood that inflation was here to stay.
Firstly, mining and construction companies like BHP Group Ltd (ASX: BHP), Bluescope Steel Limited (ASX: BSL), Mineral Resources Limited (ASX: MIN) and Oz Minerals Limited (ASX: OZL) were feeling the pinch.
“BHP, best-in-class in cost containment, cited production costs would be going up by 17% in iron ore, 21% in coal and 11% in oil,” said Hershan.
“Cost blowouts have been reported so far by Bluescope Steel (+5-10% to accelerate its North Star expansion), Mineral Resources (+24% across its business) and Oz Minerals (+13% relating to growth capex).”
Insurance companies revealed they were raising premiums like there was no tomorrow.
“Surging pricing evidenced by premium rate rises. QBE Insurance Group Ltd (ASX: QBE) delivered +10%, Suncorp Group Ltd (ASX: SUN) passed through +7% in home and +6% in motor, and Insurance Australia Group Ltd (ASX: IAG) announced +8%.”
And despite lockdowns affecting so much of the nation, the labour market seems to be tightening. This could lead to inflation from higher wages.
“Labour shortages were a theme across a number of results, including Domino’s Pizza Enterprises Ltd (ASX: DMP), Downer EDI Limited (ASX: DOW), Brambles Limited (ASX: BXB), ARB Corporation Limited (ASX: ARB), BHP Group and Commonwealth Bank of Australia (ASX: CBA) (referring to Construction),” said Hershan.
“Even CSL Limited (ASX: CSL) saw blood collection costs skyrocket by over 30%, with rising employment and lingering COVID hesitancy forcing it to move its donor incentive fees higher.”
How do investors combat persistent inflation?
So if inflation is whacking public companies, where do investors put their money?
“The issue only reinforces our preference to skew our portfolios towards high-quality companies, in attractive industry structures with strong pricing power such as Ansell Limited (ASX: ANN), James Hardie Industries PLC (ASX: JHX), Aristocrat Leisure Limited (ASX: ALL) and Resmed CDI (ASX: RMD).”
The advantage of pricing power has already been witnessed this year.
For example, Microsoft Corporation (NASDAQ: MSFT) announced last week that it would raise prices for its popular Office 365 business subscriptions.
The hike is the first major change in price structure since the launch of the cloud productivity suite in 2011, according to CNBC.