What are we looking for?
Companies that perform well during periods of growing inflation, with a focus on companies within the food and staples retailing industry.
The screen
Recent updates from two of Canada’s key economic indicators signal that the effects of the pandemic are starting take a toll on the country’s economic outlook. Firstly, Canada’s annual inflation rate rose to 4.1 per cent in August, the highest seen in 18 years. In addition, recent data from Canada Mortgage and Housing Corp. show the seasonally adjusted annual rate of housing starts fell 3.9 per cent in August compared with the previous month. Investors are questioning what options they have to ensure their portfolio returns remain unscathed.
Consumer staples is one of two sectors that have historically fared well during high inflationary periods (the other is financials). Consumer staples tends to perform better than other sectors because demand for these products stays consistent even as prices rise. Today our focus is on companies within the food and staples retailing industry.
There are several ways to measure whether companies in these industries can remain stable during high inflationary periods; today we’ll use free cash flow and Refinitiv’s proprietary StarMine Relative Valuation Model.
- First, we screen for Canadian-listed food and staples companies with a market capitalization exceeding $1-billion.
- Next, we screen for companies with a Relative Valuation (RV) Model score of 60 or higher. The RV Model score is a percentile (1 to 100) ranking of stocks based on price and enterprise value (EV) ratios. The RV Model combines information from six prominent valuation measures relevant in most equities: EV-to-sales; EV/EBITDA; price-to-earnings; price-to-cash flow from operating activities; price-to-book; and dividend yield. (EBITDA stands for earnings before interest, taxes, depreciation and amortization.) It should be noted the RV Model is highly predictive regarding the relative movement in the company’s stock price.
- Lastly, we screen for companies with a free cash flow yield over the past 12 months of 6 per cent or more. This ratio compares the free cash flow per share that a company has earned, on average, over the past year against its stock price. A higher figure means a company is generating enough cash to satisfy its continuing obligations and investors are receiving a good return on the money they’ve invested. Food and staples retailers that can maintain a higher ratio demonstrate they can sustain margins even as the cost of food production increases in a period of high inflation.
More about Refinitiv
Refinitiv, a London Stock Exchange Group business, is one of the world’s largest providers of financial market data and infrastructure, serving more than 40,000 institutions worldwide. Refinitiv provides information, insights, and technology that drive innovation and performance in global financial markets, enabling the financial community to trade smarter and faster, overcome regulatory challenges, and scale intelligently.
What we found
The screen ranked by StarMine’s Relative Valuation model produced five companies. Here are two of note:
North West Co. Inc. scored the highest in the screen with a Relative Valuation Model score of 87. The retailer has a network of stores under various banners operating in Northern and Western Canada, as well as Alaska, the South Pacific islands and the Caribbean. North West has largely benefited from a pandemic-driven sales boost; recent second-quarter earnings came in well above expectations. However, CIBC World Markets has suggested sales may struggle as vaccination rates increase in rural communities and residents can travel to shop outside of their local market. Nonetheless, throughout the pandemic, management has gained useful insight into customer demand and price sensitivity; it hopes the investments made into product and pricing will help the company hold on to market share gains.
George Weston Ltd., which scored second on the list with a RV Model of 83, is a holding company engaged in food processing and distribution business. It operates through its three operating segments, Loblaw Cos. Ltd., Choice Properties Real Estate Investment Trust and Weston Foods. Weston has fared well even as the pandemic rolls on, with a total return of 38 per cent over the past year.
Loblaw, which itself appears on our list with an RV Model score of 71, generates the majority of Weston’s profits. Loblaw’s 30 per cent gross margin is substantially higher than its peers, which helps explain Weston’s 14.7 per cent free cash flow yield.
Investors are advised to do their own research before trading in any of the securities shown.
Erik Foo, CFA, is a proposition sales specialist at Refinitiv, covering research and portfolio management sales.
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