Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Energy is your hedging friend, energy crisis spells trouble for solar
Peter Garnry
Chief Investment Strategist
Summary: The Q4 earnings season has shown that companies are facing significant headwinds on operating margins from inflationary pressures. Our analysis of the largest companies in the US and Europe shows that the energy sector and mining companies are the ones that are experiencing expanding operating margins as expected as inflation is coming from the supply side of the economy. These two themes continue to hedges against inflation and geopolitical shocks that investors should favour in their equity portfolios. We also touch on the collapse of solar stocks driven by surging poly silicon prices which interestingly enough is partly a function of the current energy crisis in oil and gas.
The regime shift in energy requires investors to embrace non-ESG companies
In some of our recent equity notes we have talked a lot about inflation and to what degree it impacts equity returns. The recent results from Home Depot, Danone, and MercadoLibre show why inflationary periods are difficult for companies. It is generally difficult to pass all of the rise in input costs as it can destroy your demand, so later in the inflationary cycle (where we are now) many companies begin absorb inflation into their operating expenses lowering operating margins and return on invested capital.
When inflationary forces are driven by the supply side of the economy, the natural hedges are in the mining and energy sectors, and to some degree financials to the extent that interest rates go up with inflation. We looked at the 537 companies (excluding financials and real estate) in the S&P 500 and STOXX 600 that have reported Q4 earnings and how their operating margin (quarterly EBITDA margin) was impacted in Q4 vs Q3 2021. The table below shows average quarterly change in %-points in the quarterly EBITDA margin across the different sectors. It is clear that energy stocks are the best hedge against current inflationary pressures, but the consumer discretionary, health care and IT sectors are also holding up well, while the industrial, communication services, consumer staples and utilities are seeing their operating margins being the most under pressure.
Where is mining companies in all of this you might wonder. Mining companies are classified under the materials sector which also consists of chemical, construction materials, packaging and paper companies, and the majority of mining companies are either not reporting quarterly financial figures or have not reported yet. It is very clear for the half-year results we have seen from miners such as Rio Tinto, BHP Group and Glencore, that the mining industry is seeing expanding margins. Again, energy and mining companies are investors’ best hedge against the current inflationary environment. But it requires that the ESG consciousness is put aside for a while.
The histogram above of these changes in the quarterly EBITDA margin also shows that the distribution is negatively skewed with the median at -0.9%-points suggesting a widespread contraction in operating margins among the largest companies in the world. The table below shows the 40 largest publicly companies in the US and Europe and their change in the operating margin. On a positive note companies such as Apple, Exxon Mobil, Walt Disney and ASML stand out as companies that have pricing power whereas companies such as Microsoft, Alphabet, Amazon, Johnson & Johnson and Home Depot are experiencing margin pressure.
| Name | Sector | Market Cap (USD mn.) | Chg. EBITDA margin in %-pts |
| Apple Inc | Information Technology | 2,681,611 | 3.5 |
| Microsoft Corp | Information Technology | 2,156,998 | -2.4 |
| Alphabet Inc | Communication Services | 1,713,282 | -3.9 |
| Amazon.com Inc | Consumer Discretionary | 1,528,543 | -3.0 |
| Tesla Inc | Consumer Discretionary | 849,058 | -0.6 |
| NVIDIA Corp | Information Technology | 584,750 | 0.5 |
| Meta Platforms Inc | Communication Services | 550,050 | 0.5 |
| Visa Inc | Information Technology | 479,048 | 1.6 |
| UnitedHealth Group Inc | Health Care | 435,175 | -0.4 |
| Johnson & Johnson | Health Care | 423,680 | -2.0 |
| Procter & Gamble Co/The | Consumer Staples | 378,569 | -0.3 |
| Walmart Inc | Consumer Staples | 378,496 | -0.4 |
| Mastercard Inc | Information Technology | 359,995 | -0.5 |
| Home Depot Inc/The | Consumer Discretionary | 330,157 | -2.1 |
| Exxon Mobil Corp | Energy | 323,699 | 3.2 |
| Coca-Cola Co/The | Consumer Staples | 270,013 | -11.2 |
| Walt Disney Co/The | Communication Services | 269,618 | 6.3 |
| Pfizer Inc | Health Care | 266,780 | -5.4 |
| ASML Holding NV | Information Technology | 259,743 | 4.4 |
| AbbVie Inc | Health Care | 257,460 | 2.5 |
| Chevron Corp | Energy | 255,226 | -3.5 |
| Broadcom Inc | Information Technology | 236,535 | 1.6 |
| Cisco Systems Inc/Delaware | Information Technology | 233,880 | 0.0 |
| PepsiCo Inc | Consumer Staples | 232,904 | -5.4 |
| Novo Nordisk A/S | Health Care | 229,970 | -7.5 |
| Eli Lilly & Co | Health Care | 228,750 | 7.1 |
| Verizon Communications Inc | Communication Services | 226,263 | -5.0 |
| Costco Wholesale Corp | Consumer Staples | 222,683 | -0.3 |
| NIKE Inc | Consumer Discretionary | 218,519 | -4.4 |
| Comcast Corp | Communication Services | 212,790 | -1.8 |
| Accenture PLC | Information Technology | 211,705 | 1.4 |
| Novartis AG | Health Care | 209,654 | -4.3 |
| Thermo Fisher Scientific Inc | Health Care | 208,802 | -1.0 |
| Abbott Laboratories | Health Care | 207,227 | -2.6 |
| Adobe Inc | Information Technology | 206,793 | 0.0 |
| Shell PLC | Energy | 202,153 | 10.5 |
| Oracle Corp | Information Technology | 197,934 | -43.6 |
| salesforce.com Inc | Information Technology | 192,203 | -1.8 |
| Merck & Co Inc | Health Care | 191,845 | 22.2 |
| Danaher Corp | Health Care | 190,319 | 7.1 |
The energy crisis is ironically slowing down the green transformation
The green transformation theme in equities has been under pressure for over year now and the longest running ETF on solar stocks (TAN:arcx) is down 46% from its peak in early 2021. There are several factors driving this with one being the price on PV grade poly silicon which is up 430% since the lows in 2020 driving up costs of solar PV panels and thus making solar projects more expensive.
There two factors behind the current high poly silicon price and those are that Chinese manufacturers increased production into excess capacity in 2018 and 2019 simultaneously with slowing demand of solar projects amplifying the oversupply issues. In 2020, no new capacity was added in China and through massive stimulus and focus on green energy projects demand came back roaring in 2020 and 2021 pushing up demand way above supply. In addition global logistic costs have gone up increasing total costs of solar panels even more and the energy crisis in China has also pushed up prices on coal which is the main energy source for electricity production in those regions producing poly silicon. With high energy costs expected on traditional energy sources we can expect poly silicon prices to remain high impacting demand for solar projects.
It is an irony that an energy crisis and metals scarcity are causing the green transformation to slow down. It is becoming clear that the green transformation cannot be a binary transition without investments alongside in oil and gas.
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