Energy is your hedging friend, energy crisis spells trouble for solar

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.