Extreme inflation won’t last and neither will this stock’s negative returns amid push for ‘net zero’
Few equity investors have beaten inflation over the past year. While the FTSE 100 has posted a 2pc gain that rises to about 6pc when dividends are included, annual price rises have been in excess of 10pc. Therefore, the value of most stock portfolios will be lower now in real terms than they were a year ago.
In Questor’s view, this is to be expected during a period of rampant inflation. After all, rapid price rises have prompted a sharp increase in interest rates, from 0.75pc a year ago to 4pc today, that have caused a severe slowdown in Britain’s economic growth rate. And with a similar story in America and Europe, in terms of extreme inflation and accelerated interest rate rises, the global economic outlook has also deteriorated.
Since investor sentiment is heavily influenced by the economy’s current performance and near-term prospects, shares could continue to deliver negative after-inflation returns in the short run. But, over the long term, their prospects remain extremely bright as investors pivot from panic to euphoria due to falling inflation, an abatement of interest rate rises and an improving economic outlook.
As a result, this column is unconcerned about the 20pc decline in engineering company Spirax-Sarco’s shares since they were added to our wealth preserver portfolio in July 2021. Indeed, it released an encouraging set of full-year results last week that showed it is making excellent progress in implementing its long-term strategy.
The company delivered a 20pc rise in revenue amid a tough economic and geopolitical environment; benefiting from volume growth and price increases. Although its adjusted operating profit margin declined by 1.7 percentage points year-on-year to 23.6pc, the previous year’s comparative was exceptional. Margins also moderated due to ongoing investment in growth opportunities that are expected to produce higher sales in the coming years.
For the current financial year, the company expects to post a modest increase in its adjusted operating profit margin. This is encouraging given that many firms are struggling to pass higher costs on to customers during the present era of extreme inflation.
Acquisitions added 6 percentage points to the company’s revenue growth in 2022 and also aided margins. Due to it having a modest net debt-to-equity ratio of 65pc and net interest cover of about 40, it is in a strong financial position to make further acquisitions to improve its competitive position while asset prices are at a relatively low level.
Although investor sentiment towards the company has withered over recent months, Spirax-Sarco’s long-term growth potential remains robust. It is well placed to benefit from the world’s push to achieve “net zero” over the coming years, with its range of decarbonisation solutions likely to prove popular. An ability to improve the efficiency of its clients’ processes is also likely to be in high demand.
With a broad range of customers across a wide variety of industries, the company is well-diversified amid an uncertain period for the world economy. And with many of its efficiency-related solutions offering short payback periods and being paid for from operating, rather than investment, budgets, its financial performance is likely to remain sound even if the global economic slowdown worsens in the near term.
Trading on a forward price-to-earnings ratio of about 27, Spirax-Sarco still has a premium valuation despite its recent share price fall. While some investors may deem it to be overpriced given the uncertain economic outlook, Questor remains upbeat about its capacity to deliver inflation-beating returns over the long run.
The company’s growth catalysts, which were a key reason for its addition to our wealth preserver portfolio, remain intact as a variety of industries seek to become more efficient and shift to more sustainable practices. And with margins remaining relatively high in spite of rampant inflation, and forecast to rise in the current year, it is in a strong position to deliver a growing bottom line even as many companies struggle.
Perhaps more importantly, though, investor sentiment is very likely to improve over the coming years as the world economy’s performance reverts to its long-term average. Although weak sentiment has worked against the stock, and equity markets in general, during the current era of high inflation, history suggests the status quo of negative real returns will not be maintained.
Questor says: hold
Share price at close: £110.75
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