No-one complained when central banks and governments around the world opened the purse strings to try and nullify the impact of the pandemic on economic growth and jobs. However, all the money and market distortions created come at a cost, and we are in for a period of destabilsation as the support is turned off and economies revert to normal market drivers.
The process has been exacerbated by the Eastern European conflict and its dramatic impact on energy prices, adding to an already building inflationary shock across the globe. Needless to say, share markets are jittery.
In this environment leading corporates often have an advantage, as they can leverage robust balance sheets to adapt to changing conditions and often have significant market share, allowing cash flows to be maintained even if margins come under pressure. Balance sheet strength is also an important factor in how our biggest companies maintain dividend payout ratios during more difficult periods, as well as providing flexibility to access a variety of debt instruments to manage the impact of rising interest rates.
In this environment we look towards corporates that have defensive characteristics against volatility in their operations, and may get beneficial effects from rising interest rates and inflation.
We have selected three leaders in Australian industries that have potential to thrive in a defensive portfolio.
- Macquarie Group - Rate tightening cycles will deliver a ‘sweet spot’ for bank earnings.
- Rio Tinto - Commodities will continue to benefit from inflationary pressures and continuing geopolitical volatility in Europe.
- CSL - Pharmaceuticals will continue to remain relevant as the global population ages and healthcare expenditure increases
Macquarie Group (MQG)
Macquarie Group’s recent Operational Briefing has given commentary around a ‘record quarter’ for the group with net profit after tax of $1.3bn. This bumper performance was supported by significant gains in commodities revenues (gas & power) and Macquarie Capital’s fees and investment realisations.
Macquarie Group is well placed to exploit emerging volatility in energy markets, particularly gas. Additionally, the group has benefitted from Macquarie Capital’s strong exposure to merger and acquisition activities driving transaction activity (fees).
- Globally diversified: A leading investment bank with offshore income now accounting for more than half of group profits. Long term upside from exposure to rapidly expanding overseas growth markets.
- Broad diversified revenue base: Operational base with significant activities in corporate finance, treasury & commodities, equity markets, funds management, and an up-and coming retail banking arm.
- Promising long-term opportunities: Longer-dated exposure to green energy, these are tangible with longer-dated benefits. Macquarie has an investment pipeline of over 300 renewable energy projects, this gives it strong upside exposure to the global structural changes needed to address climate change.
Rio Tinto (RIO)
Rio Tinto has benefited from strong commodity prices, this has allowed it to address global inflationary pressures, including rising input prices, labour costs, and higher processing plant maintenance costs. Recent investments in and the ramp-up of the Gudai-Darri iron ore mine in Western Australia have helped partially offset these increased production costs. Recent full-year dividends have been in-line with market expectations, and have been accompanied by a record level of dividend payment.
- Competitive advantage in low-carbon smelters: Rio has a high proportion of lower emission hydro powered aluminium smelters, a particularly strong advantage as global aluminium is forecast to grow at 3.3% a year. This is significant as global markets will start pricing in carbon costs (e.g. European Union Carbon Border Adjustment Mechanism)
- Growth minerals production portfolio: Rio is among the world leaders for iron ore and aluminium, with significant upside in copper. These three commodities are expected to account for over half of the new incremental metal demand resulting from the global energy decarbonisation transition.
- Global growth exposure: Rio Tinto has significant exposure to Asian growth markets including China and Japan. Asia (including China and Japan) account for roughly 75% of revenue as at FY2020.
CSL’s planned acquisition of Vifor will add value to shareholders. CSL has demonstrated over the last 25 years that it can deliver high rates of return on capital. The current annual research and development budget of $900m-1000m, in addition to an announced capital expenditure investment in excess of $1 billion a year over the new few years, will enable the company to maintain its market leading position in innovation.
- Global leader in plasma: Plasma products have a wide applications with benefits which are hard to replicate. CSL has roughly 85% of earnings derived from plasma fractionation. This has enabled the sector to deliver around 9% revenue growth annually over the past 25 years, with this trend expected to continue.
- Strong R&D Investment to maintain leadership: CSLs annual R&D investment of $US900 million to $US1 billion, in combination with over $US1 billion of capital expenditure a year will enhance its innovative market leading position.
- Vifor acquisition and product diversification: CSL recently acquired Swiss-based Vifor, a world leader in iron deficiency, renal, and cardio-renal therapies. This transaction provides diversification benefits as it moves CSL away from influenza vaccines and immunoglobulin products. This is valuable as these two products may be threatened by recent new market competitors, however, it will not be until 2023-2025 the impacts of these competitors are clear.
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Any advice is general advice only. It was prepared without taking into account your objectives, financial situation, or needs. You should also obtain and consider the relevant Product Disclosure Statement and terms and conditions before you make a decision about any financial product. Investors are advised to obtain independent legal, financial, and taxation advice prior to investing. Past performance is not an indicator of future performance.