Has your portfolio beaten the rate of inflation this year? The answer for most investors has been a resounding no, as stocks, bonds, real estate, crypto and more have fallen. Ironically, amid the wreckage, cash has served as a better hedge than these asset classes. Call this counterintuitive finance, but do not expect cash to continue outperforming. In the long run, inflation still will eat up purchasing power, while corporations will slowly pass on costs to customers, increase prices, and find ways to maintain their cash flows.
Investors should expect equities as an asset class to outperform inflation over time, but there are certain sectors that have historically performed better than others. Energy, precious metals and soft commodities – commodities that are grown – tend to excel, while utilities, real estate and real estate investment trusts can do well or poorly during inflationary periods, depending on how much debt they are carrying and the interest they must pay as rates rise.
Here at Contra the Heard Investment Newsletter, we have been examining investments in these sectors closely. One company we purchased this year in the soft-commodity space is Fresh Del Monte Produce Inc. (FDP-N). The enterprise is an agrifood operation known for its bananas, pineapples and other fresh fruits and vegetables.
The vertically integrated nature of Fresh Del Monte’s operations gives it a significant degree of control over its supply chain. In 2021, 43 per cent of its produce was grown on its company-controlled farms. In addition to owning a good chunk of land, the company also possesses refrigerated ships and containers, trucks and warehouses. The enterprise has more than two dozen chopping and packaging facilities in North America, and 42 distribution centres as well. It does rely on some third parties to grow, move and process some products, but Fresh Del Monte has an impressive logistical reach, which should act as a competitive edge if supply chain tightness and inflation persist.
In addition to the integrated supply chain and solid potential as an inflationary hedge, its investment thesis is strong. The company’s valuations are low, the balance sheet is sound, and it has generated consistent income and cash-flow statement metrics for years. We also like the dividend and the buyback program. Since 2012, the share count has fallen from 58 million to 48 million. Additionally, Mohammad Abu-Ghazaleh, the company’s chief executive officer, has solid alignment with other owners via a 29.8-per-cent stake in the organization.
Shortly after our purchase in June, at US$24.26, two outside parties expressed interest in acquiring the company. First, in July, infrastructure investment firm I Squared Capital announced it was looking to expand its partnership with Fresh Del Monte, including a possible acquisition. Then, in September, management reported they had takeover interest from an undisclosed private equity firm. Though nothing may come of these expressions of interest, possible M&A could be a bonus for owners. It is easy to see why an acquisitor might close in with the stock trading at around US$27 and the book value north of $39.46.
There are numerous pillars supporting Fresh Del Monte’s investment thesis. However, in the months after our purchase, our assumptions that the company would push costs onto consumers and maintain its margins fell flat. The company’s second-quarter numbers saw sales surge but net income fall, net margins were only 1.74 per cent, and earnings per share clocked in at 43 US cents versus consensus estimates of 74 US cents. Going into the latest earnings we were a little pessimistic. To our surprise, however, margins expanded, and third-quarter EPS came in at 54 US cents against expectations of 10 US cents. A beat of this magnitude is unusual, which suggests analysts were also surprised. This contrast between the second- and third-quarter numbers highlights an interesting consideration for investors: Though a company may be a relatively good inflation hedge, the questions around when it will be able to push costs and by how much are open-ended and hard to time. Therefore, a degree of patience is needed, as well as an acceptance that perfect timing is unlikely.
Heading into the new year, we anticipate the company will continue to push price increases onto customers and grow its top line. If it can do this, the stock should perform well during this inflationary period. Indeed, it may be worthwhile for investors sitting on cash to convert some of it into stocks that have the ability to raise prices, Fresh Del Monte being a good candidate.
Alternatively, if a recession does occur and inflation cools, food staples should be somewhat resistant to economic contraction. This is because people always must eat regardless of recession or expansion. From this vantage point, Fresh Del Monte appears well-positioned for 2023 regardless of inflation’s trajectory.
Philip MacKellar is a writer for the Contra the Heard Investment Letter.