Seeking inflation protection through companies with utility-like characteristics
17 Aug, 2022
By Stephen Anness, Head of Global Equities at Invesco
Key takeaways:
1. Utilities are necessities and are therefore the last costs we cut when times are hard. As a result, providers often have the power to raise prices in line with inflation, which could help their share prices in times like these.
2. When most people consider utilities, they think of electricity, water and telecoms. However, these utility-like qualities can also be found in other sectors – some of them perhaps surprising.
3. From technology to lifts, read on to discover the sectors where these utility-like qualities can also be found.
When most people consider utilities, they think of electricity, water and telecoms. These are necessities and are therefore the last costs we cut when times are hard. Consequently, providers often have the power to raise prices in line with inflation, which should help their share prices in times like these.
These utility-like qualities can also be found in other sectors – some of them perhaps surprising.
Take technology. Microsoft Office is so deeply embedded in workflows worldwide that replacing it with a new system would be an enormous task for any Chief Technology Officer. Consider how many companies relied on Microsoft’s video-conferencing software, Teams, to continue working during the pandemic – and how many continue to use it today to support hybrid working.
In Microsoft’s early days you would buy software on a CD and upload it to your machine. This meant you could delay buying an update until it was absolutely essential. It also left the software vulnerable to piracy.
Nowadays, however, most people use a subscription model. This means software is downloaded online and constantly updated. It also means you have to continue paying if you want to use it, which gives Microsoft a constantly recurring income and allows the company to pass on inflation costs to consumers.
Communications frameworks
Another business with such qualities is American Tower – one of our biggest holdings. The company owns and operates wireless and broadcast communications infrastructure – the towers that hold satellite dishes for phone companies. It has around 221,000 sites across six continents.
Individual phone companies would struggle to build towers just for their own dishes as competitively as renting from American Tower, so the business has very high levels of client retention. Maintenance costs are low, so it has strong recurring income. And the fees it charges for renting tower space are typically linked to inflation.
The phone companies themselves are good at passing on costs. This is because, though we can put off upgrading handsets, few of us can survive without a mobile phone service. So income looks secure, too, in our view.
Audio
We cannot claim that music is as essential to life as water or electricity. Nonetheless, it is still one of the last costs consumers cut. In a world where few of us buy CDs anymore, streaming services like Spotify have become the equivalent of toll roads for music consumption.
Earlier this year we bought shares in Universal Music Group (UMG). UMG owns and operates businesses engaged in music recording, publishing, merchandising and creating audio-visual content.
It owns the music rights to many of the world’s best artists – past and present. It clips royalties every time its artists are streamed. In addition, modern technology means it can monetise its catalogue better than ever, picking up when music is being used for commercial purposes online and by broadcasters. Film producers, advertisers and videogame creators all use music – and must pay for it.
Lifts
Once you start looking for these qualities, you find them everywhere. Lift manufacturer Kone is another example. Much like the computer software sector, there are only a handful of major players in the lift and escalator industry – Otis, Schindler, Kone and Mitsubishi Electric.
Lift companies make most of their profits from ongoing equipment maintenance rather than from installation. Installing a new lift is expensive and time-consuming and can cause major disruption, especially in large office blocks with hundreds of people going in and out all day long. A building owner is unlikely to install a new lift without good reason. Additionally, there are usually regulations imposed upon owners of public buildings, requiring them to have their equipment serviced regularly – meaning recurring income for manufacturers.
Inflation protection
Companies with utility-like qualities can be susceptible to regulatory oversight and, like all businesses, are vulnerable to disruption. There is always the risk of their share prices falling and investors losing money. But we believe the qualities we have outlined help mitigate many risks, making them appealing to us in the current environment.
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