Long-term drivers of company growth remain robust

The conflict in Ukraine means European companies are contending with a steep rise in inflation, higher energy prices and a weakening of both consumer and business confidence. The inflation rate in the Eurozone reached 8.1% in May, which is the highest level since 1983.

In addition, there is uncertainty about what will happen next in the war and to what extent Russian gas exports to Europe will be reduced. So, the economic backdrop for European companies contains a number of challenges.

However, inflation and energy prices are unlikely to stay at these elevated levels indefinitely. If rising costs and reduced confidence result in a slowdown in economic growth, that is likely to put downward pressure on inflation and energy prices.

A slowdown is also likely to persuade policymakers to take a more cautious approach to increasing interest rates and withdrawing quantitative easing. In very broad terms, this should benefit businesses.

In the meantime, the companies we talk to are telling us they are still trading strongly. Industrial businesses are among those most exposed to the rising cost of raw materials such as steel, wood and copper. They tell us though that general awareness about the scale of the global inflation shock has made it easier to pass on rising costs to their customers. Meanwhile, demand for goods and services remains strong because of pent-up demand still lingering from the pandemic.

“It is interesting to note that takeover activity in Europe, which had been subdued, has begun to increase in recent months. Companies are clearly seeing value with share prices at this level.”

When we invest, we seek out companies that have first-class management and a proven business model and where the share price does not, in our view, reflect the growth potential of the business. As part of this, we look for long-term growth drivers supporting the company’s expansion. It is important to remember that, despite rising inflation and the war in Ukraine, these growth drivers remain firmly in place.

For example, we invest in a French company called Delta Plus, which is a manufacturer of personal protective equipment for industry, including helmets, masks and safety harnesses. The long-term growth driver is rising demand for the company’s products because of increasing health and safety standards in both the developed world and developing economies. This driver remains as strong as ever.

Another French company we hold, Mersen, makes sophisticated components used in electric motors and in the manufacture of solar panels. Here the growth driver is the rapid expansion of renewable energy production and electric vehicles and, again, this driver remains very robust.

Looking ahead, there is clearly uncertainty. However, this is also creating opportunities. This year’s stock market sell-off means high-quality companies are now on significantly lower share prices than they were 12 months ago. It is interesting to note that takeover activity in Europe, which had been subdued, has begun to increase in recent months. Companies are clearly seeing value with share prices at this level – and we too are taking the opportunity to top up our investments in high-quality companies at significantly lower valuations.

David Walton, 30/06/22

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