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OCBC favours firms with pricing power to withstand potential inflation tantrum

Ng Qi Siang
Ng Qi Siang 5/3/2021 03:28 PM GMT+08  • 3 min read
OCBC favours firms with pricing power to withstand potential inflation tantrum
Buy firms with greater leeway to boost prices to protect yourself from inflation.
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With Covid-19 recovery underway, investors are increasingly worried about the impact of inflation on their portfolios. To combat this, OCBC Investment Research recommends that investors buy into firms with greater ability to boost prices going forward.

To be sure, deflationary forces are still present in the market as employees remain furloughed, keeping a lid of wage deals. Still, the OCBC Research Team sees a post-vaccine world releasing significant amounts of accumulated savings into the economy, resulting in a sharp rise in prices. Supply in some sectors may not keep up with post-Covid demand.

This is especially in sectors where capacity has not survived the lockdown. It will take time for restaurants, entertainment venues and hotels to return to full capacity. The tighter supply amid greater demand is likely to see prices rise sharply in the wake of economic normalisation.

“Besides the potential for higher wage costs in the future, other input costs such as commodity prices would also impact margins. Against such a backdrop, it is useful to identify companies that look to have greater capacity for price boosts in the future,” writes the research team in an OCBC research report.

Top of the counters identified by OCBC are Imperial Brands and British American Tobacco on account of their robust 103% and 60.4% upside respectively. Being an oligopolistic industry with a few large players, companies tend to avoid a “race-to-the-bottom” for prices since price rises are the only way that profits increase. Moreover, tax usually accounts for 70-80% of the retail price of cigarettes and consumer loyalty is strong, serving as a disincentive to slash prices.

Consumer discretionary also looks good, with BMW and Continental reporting 47.9% and 48.2% upside respectively. The former has been able to produce vehicles with superior pricing and margins that generate revenue increases exceeding vehicle growth rates due to strong branding, technological leadership in power trains and ability to command premium pricing.

“Continental’s consistent product or process technology innovation, combined with the ability to commercialise new technology, enables more favorable pricing relative to many automotive industry suppliers overall,” reports OCBC. A serial patent-filer, Continental commands a premium for its strong product differentiation and diverse customer bases in varying geographic locations, as innovative technology can be reserved for customers willing to pay. .

Healthcare players GlaxoSmithKline (GSK) and Roche command an upside of 34.7% and 44.9% respectively. Besides a wide economic moat, powerful distribution networks and economies of scale, GSK enjoys strong pricing power due to its patent-protected drugs, which gives it an edge over generic competition. Roche also has strong brand power, which sees consumers willing to pay a premium for its drugs despite longtime competition.

Hong Kong remains OCBC’s preferred real estate playground given resilient housing demand and low land and housing supply amid cooling measures in Singapore and China. They expect residential prices to bounce back in 2021 despite a 1.1% dip in 2020. Hongkong Land, Henderson Land, Swire Properties and Sun Hung Kai have all been highlighted.

“We suspect that companies that have greater flexibility to lift prices can generate more profitability and hence have a very plausible way to improve returns (via margins, ROE, ROA, FCF, etc.), which should be rewarded by the investment community,” notes OCBC Research. But given the disrupted state of the global economy, whether this truly plays out is anyone’s guess.

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