What are we looking for?
Companies relatively well positioned in an inflationary environment.
Inflation has arrived – Canadian consumer prices rose by 3.4 per cent year-over-year in April, which is the fastest rate in nearly a decade. Historically, such periods of rising inflation are accompanied by increased wages and interest rate hikes, which affect many companies by cutting into profit margins. Household names such as McDonald’s Corp., Under Armour Inc. and Chipotle Mexican Grill Inc. have already announced wage hikes, signalling the start of a longer-term trend. Whether this inflation is transitory or permanent remains a hotly debated topic. But investors can prepare themselves by identifying sectors and companies that could benefit from continued price increases while minimizing the impact of rising wages.
The screen
To begin our analysis, we used FactSet’s universal screening tool to pull all publicly traded securities on the Toronto Stock Exchange. In order to exclude less established businesses, we only included companies with a market capitalization of more than $1-billion.
Next, we narrowed down our universe to those that are in the energy, non-energy materials or finance sectors. Energy and materials companies tend to be commodity producers, be it natural gas or copper, which benefit from rising commodity prices. Finance companies can benefit from rising interest rates through higher lending rates.
We then looked at firms with a low employee count, which can provide a buffer against increasing wages. We only included companies that scored better than the calculated median of three metrics in our universe of 156 results:
- Sales per employee greater than $900,000;
- Net income per employee greater than $100,000;
- Assets per employee greater than $6.3-million.
That left us with 22 companies that fit our criteria; ranking those by sales-per-employee figures we came up with a top 10 list.
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What we found
At a sectoral level, real estate was strongly represented with three companies passing our screen. Physical assets tend to appreciate during periods of rising inflation and the companies represented here could benefit from this appreciation while being protected against rising wages as they have fewer employees.
Fewer energy companies made the cut – only two. While energy firms may benefit from rising commodity prices, they tend to have more employees than the broader market. Additionally, the screen requirement to have a positive net income per employee, implying that a company remained profitable last year despite the plummet in commodity prices, ruled out numerous energy companies.
E-L Financial Corp. Ltd., an investment and insurance holding company, topped our list with $122.3-million in sales per employee. As a holding company with only 13 employees, however, it derives a substantial portion of revenue from its investment in Empire Life Insurance Co., which has 900 employees. Hence, its reported revenue and profitability will be tied to the performance of its subsidiary.
Four precious metals royalty companies are on the list, led by Wheaton Precious Metals Corp., ranked at No. 2. These companies operate by providing capital to precious metal producers in exchange for a royalty on sales from that asset or mine. (Note that one of these royalty companies, Triple Flag Precious Metals Corp., is classified by FactSet in the finance sector.) As a result, they require few employees, minimizing their risk of rising wages, while participating in the upside associated with rising commodity prices and production.
It is worth pointing out the 10 companies as a group have a year-to-date total return of 18.2 per cent, far exceeding the broader market. If the inflationary and wage trends continue, there may be further upside ahead.
The information in this article is not investment advice. FactSet assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained above.
Arjun Deiva, CFA, is a vice-president at FactSet Canada’s consulting division.
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Arjun Deiva, CFA