💪 Who Has the (Pricing) Power?

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THE STREET SAYS

Good afternoon everyone, happy Sunday. Two weeks ago, we asked if you think March's year-over-year CPI reading will be higher or lower than 8.3%? 52% of you said HIGHER, while 48% of you said LOWER.

Congrats to those of you that said, HIGHER. CPI in March jumped by 8.5% from a year ago, the fastest annual gain since December 1981.

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REVIEW

US stocks fell Friday as investors reacted to the latest indication from the Fed that its monetary policy will significantly tighten in the coming months.

A day earlier, Fed Chair Jerome Powell suggested the central bank is prepared to hike rates by 50 basis points at its meeting in May. This comes as the market remains highly concerned about inflation, which has been a focus, as companies share their results amid soaring prices.

Meanwhile, the bond market selloff appeared to stabilize at the end of the week. The yield on the 10-Year US Treasury has been rising recently, and again, at one point on Friday, went over 2.9%, hitting a three-year-high.

Volatility has been a theme for commodity prices as well, especially since Russia’s invasion of Ukraine, which rattled energy markets in particular. Oil prices fell to close out the week.

On the economic front, both manufacturing and services expanded at a slower pace this month compared to March, according to S&P Global Mobility’s purchasing managers survey. The market intelligence firm’s chief economist says this suggests a slight loss of momentum, relative to what was a strong rebound in March.

In company specific-news, American Express reported first-quarter profit that was lower than the same period in 2021, despite increased spending on travel and entertainment.

Clothing and accessories retailer Gap cut its first-quarter sales guidance, as executives pointed to “execution challenges” within the Old Navy division.

HCA Healthcare saw its share price slide lower after issuing downbeat guidance for 2022.

Verizon Communications said it lost fewer-than-expected phone subscribers during the first three months of the year, which could be a sign the company’s massive investment into 5G expansion and new broadband networks is paying off.

Snap reported revenue that failed to meet Wall Street expectations.

On the upside, steel producer and mining company Cleveland-Cliffs beat top and bottom-line estimates.

For the week as a whole, the Dow Jones Industrial Average lost around 640 points or 1.9%. The S&P 500 fell 2.8%. The Nasdaq Composite shed 3.8%.

PREVIEW

Tomorrow the Chicago Fed will release last month’s National Activity Index, after the reading edged downward in February, indicating a slight decrease in economic growth. The Dallas Fed will also publish that region’s Manufacturing Index for April.

Tuesday, several data points related to the housing market will be published, including March’s new home sales. The number came in 2% lower in February, falling short of earlier estimates. Analysts say elevated home values and rising mortgage rates have forced a significant number of would-be buyers to continue renting. March’s durable goods orders are also due, as well as this month’s consumer confidence index.

Wednesday, when MBA mortgage applications are released, the market will look to gain further insight on how increased mortgage rates have affected the housing market, as well as the average rate for a 30-year fixed loan. Also, watch for the first-quarter’s home ownership rate and last month’s pending home sales.

Thursday, jobless claims are due, after the most recent report indicated 184,000 Americans filed for unemployment benefits, which slightly exceeded estimates. Still, it marks the lowest such number in 52 years, as the tight labor market continues.

Friday, be on the lookout for March’s personal consumption expenditures index or PCE, which is the Fed’s preferred inflation gauge. In February it showed prices increasing by 6.4% on an annual basis. March’s personal income and spending are also set for release.

Here’s what to keep an eye of for in this week’s earnings reports:

Tomorrow, video game giant Activision Blizzard (ATVI) will hand in its latest report card. Reports indicate the company’s popular World of Warcraft, Hearthstone, and Call of Duty franchises have expanded their user bases which helped boost in-game spending.

Tuesday, JetBlue (JBLU) will publish earnings, during what’s been a busy earnings season for the airline industry as a whole.

Wednesday, Ford (F) is set to share its latest quarterly data, providing the market with a look at how one of the nation’s largest automakers is navigating inflationary pressures and the ongoing chip shortage.

Thursday, fast food industry leader McDonald’s (MCD) is scheduled to release earnings for its most recent quarter. 

Friday, Chevron (CVX) will share its first-quarter results after posting a mixed earnings report for Q4 2021 during which the oil giant missed on earnings but beat on revenue.

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Supply Chain Pain is Warehouse Stocks' Gain

Why Demand Could Soar 

Supply chain snarls have been a huge headache for manufactures and retailers, who have struggled to maintain enough inventory to meet consumer demand. Amid that backdrop, Prologis (PLD) and other warehouse stocks represent an opportunity, as companies are stockpiling goods in order to overcome delayed deliveries.

Currently, just 7% of shipping containers that leave Asia arrive in North America on time. The figure is even worse for shipments coming from Europe, which have an on-time rate closer to 6%. The latest COVID-19 shutdowns in China and impending labor negotiations with dockworkers in the US could cause further delays. That would likely result in even more stockpiling at warehouses, driving up demand for that space.

Double-Digit Rent Hikes

Warehouse stocks such as Prologis and Europe’s Segro (SEGXF) may also benefit from the market’s tight supply, which enables them to increase rents to offset the impact of inflation. Last year, US vacancy rates for warehouses fell below 4% for the first time ever, while the number hovered around 3.5% in Europe. US rents for warehouses jumped 11% last year, while some parts of Europe saw an even more significant 30% increase.

Prologis expects to raise rents by 11% in 2022. Warehouse owners admit they’re reluctant to lock in long-term leases, fearing they could miss out on even more upside.

Investor Cash Pouring In 

Strong demand and tight inventory is driving investor interest in Prologis and Segro. In January, Prologis became the largest listed REIT in the US based on market value. Segro, Europe’s second-largest REIT, says real estate investment capital is largely targeting the industrial sector and logistics.

Analysts note both Prologis and Segro face risks despite the established upside. Manufacturers could choose to move production closer to home, reducing the need to stockpile goods. That would be a costly endeavor but one that’s currently under consideration. Regardless, current trends suggest warehouse stocks could keep climbing, as both manufacturers and retailers continue to stock up.

Pricing Power Rules in an Inflationary Environment

Seeking Profit Machines 

With inflation at a 40-year high, companies are finding it harder than ever to maintain profit margins. Those that command strong pricing power have a better chance of success, all while navigating the changing environment. 

When prices rise, the companies that sell products in limited supply or have few competitors tend to be successful. They can more easily pass increased costs on to customers in the form of price hikes. Increasing productivity and cutting expenses can also help companies achieve more pricing power.

Who Has the Power?

Companies that have focused on free cash flow over the past two years are in a strong position. Doing this during the pandemic also points to a business model that can survive downturns.

Two industries that currently maintain pricing power are tech and healthcare. Both sectors have seen companies raise prices while managing higher expenses. So far, it appears that customers are willing to pay these increased prices, which means profit margins have held steady.

Tech firms including Microsoft (MSFT), Nvidia (NVDA), and Broadcom (AVGO) have pricing power because they sell products that stand out from their rivals. In the case of Nvidia and Broadcom, each company makes semiconductor chips, which can’t be produced fast enough amid a worldwide shortage. Microsoft continues to dominate the computer operating system market. These companies' products and services require upgrades that cost money, and customers are willing to pay.

Some names from the healthcare sector that stand out include Merck (MRK), Zoetis (ZTS), and Mettler-Toledo International (MTD). Spending on most medicines and procedures is non discretionary, and these companies offer the latest treatments. For example, Merck received FDA approval for its next-generation pneumococcal vaccine last summer, while Zoetis is a leader in animal health products, and Mettler-Toledo International makes equipment needed for labs and other medical research.

Name Brands Pass it Along

Leading name brands are typically able to pass increased costs on to consumers without too much backlash as well. For example, McDonald’s (MCD) and Yum! Brands (YUM) raised prices last year as each company faced higher costs. The golden arches were hit particularly hard by labor and commodity inflation, which topped 6% in 2021.

Rockwell Automation (ROK), General Electric (GE), and Lockheed Martin (LMT) are also seeing their margins expand despite higher prices. Rockwell’s price increases are aimed at offsetting input costs, while GE is focused on cutting costs and spurring innovation in a bid to grow.

Some market watchers argue the economy is slowing, despite inflation’s relentless march higher. Investors are looking for firms that can both successfully protect and grow their bottom lines despite these challenges.

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Will Invest for Cash: Digging Deeper Than Dividends

Free Cash Flow Matters… A Lot 

Income seeking investors need to be thinking beyond whether or not a company rewards shareholders with dividend payouts. In order to ensure companies can maintain and hopefully increase their dividend, look at free cash flow. Without it, a company may cut, halt, or do away with its dividend. Worse, it may need to borrow money just to keep the quarterly or annual payouts coming.

That’s why free cash flow is so vital, broadly speaking. It not only assures companies can pay a dividend, but also allows for debt reduction. Free cash flow also makes it possible for companies to buy back shares, invest in growth, and make acquisitions — all of which should help the stock appreciate.

Tracking Insurance and Biotech

So, which companies make the cut when it comes to free cash flow? Both the insurance and the biotech sectors are worth considering. Chubb (CB), the property and casualty insurance company, sports a free cash flow yield of about 14.7%. The firm ended 2021 with free cash flow of $11.1 billion. Last year, Chubb spent roughly $1.4 billion on dividends and bought back $4.9 billion of its stock.

Biopharmaceutical company AbbVie (ABBV) also maintains an impressive free cash flow yield of 9.1%. The company’s big profit maker is Humira, its blockbuster drug for rheumatoid arthritis.

Pivoting away from healthcare, agricultural company Archer Daniels Midland (ADM) maintains a free cash flow yield of 14.2%, ending 2021 with $5.4 billion in free cash. The company spent about $834 million last year on dividends, representing a 3% year-over-year increase.

Upside in Energy

As commodity prices rise, especially the price of oil, energy companies have also been able to grow their profits. For example, Chevron (CVX) has strong cash flow, ending 2021 with a yield of 9.6%. Broadly speaking, it’s benefiting from soaring gas prices. In 2021, Chevron had total free cash flow of $21.1 billion.

Fellow energy giant Exxon Mobil (XOM) is another interesting option, with a free cash flow yield of 13.8% in 2021. The company ended the year with $38 billion in free cash, $15 billion of which went to dividend payouts.

Income-seeking investors should go deeper than just the dividend payout. By looking at broader trends, it may be easier to decide if a company can maintain its cash flow. Otherwise, dividends have a way of drying up

This communication from The Street Sheet is for informational purposes only. It is not intended to serve as a recommendation to buy, sell, or hold any security and is not an offer or sale of a security.  Information contained within should not be perceived as a research report and is not intended to serve as the basis for any investment decision. Any third-party views reflected herein do not reflect the opinion of The Street Sheet. All investments involve risk and the past performance of a security does not guarantee future results or returns. There is always the potential for financial loss when investing in securities or other financial products. Investors should consider their investment objectives and risks before investing.