Stagflation fears stalk markets and rising costs to take a bite out of Greggs’ expected

“After a Lazarus-like turnaround yesterday the FTSE 100 was back under pressure on Tuesday as the war in Ukraine grinds on and approaches the end of its second week,” says AJ Bell Investment Director Russ Mould.

“It’s hard to believe that just a fortnight ago a full Russian invasion was considered the worst end of a range of scenarios, oil was trading at less than $100 per barrel and Germany’s defence strategy had not been transformed from a long dovish to a much more hawkish posture.

“The costs of isolating Russia through sanctions continue to bite, with a threat from the Kremlin to cut off gas supplies. There is also continuing talk about an oil import ban, even if European countries seem reluctant.

“Stagflation, an ugly mix of inflation and recession, is the fear stalking the markets right now and the longer the war rages, the more likely this scenario becomes.

“Meanwhile gold’s safe-haven credentials have been burnished by this crisis as the precious metal trades above $2,000 per ounce.

“In corporate news Domino’s Pizza may have delivered a share buyback to investors but they don’t appear to be won over.

“The company posted a higher annual profit, crediting a successful marketing campaign and England’s success in last summer’s Euros, but the focus was on a slowdown as we move out of lockdown and the inflationary and recruitment challenges facing the business.

“Furniture retailer Made.com has had a torrid start to life as a public company, trading nearly two thirds below its 200p issue price last summer. Its full year results offered little cheer to shareholders as the company posted a loss thanks to rising freight costs and supply chain issues.

“The company does enjoy balance sheet strength and there is a bit more stability to the business now interim CEO Nicola Thompson has been confirmed as staying in the role on a permanent basis, however there must be concern that a mounting cost of living crisis will depress demand for big ticket items like sofas.

“Luxury watch seller Watches of Switzerland indicated negligible exposure to Russia and Ukraine and guided for revenue towards the top end of expectations. However, to what extent high net worth individuals from Russia but living overseas accounted for demand remains to be seen and hard for the business to judge.”

Greggs

“It was inevitable that the price of a sausage roll would have to go up again in the current inflationary environment, but to Greggs’ advantage is its low prices relative to many other ‘food on the go’ retailers such as Marks & Spencer.

“The nation is having to get used to more expensive products and a company like Greggs has three main options to deal with this situation.

“It could stomach all the extra raw material and running costs and keep prices the same, which would hurt its profit margins. Second, it could go down the shrinkflation route and make products smaller while selling them at the same price as the older, larger versions. Or it could simply pass on the costs to the customer through higher prices.

“When you’re talking current prices of a pound or so, nudging up prices by 10% or 20% isn’t going to break the bank for most customers, and so Greggs is perhaps better placed than larger-ticket retailers to cope with the current inflationary environment.

“This year is proving to be a real challenge for consumer-facing businesses as the cost-of-living spirals ever upwards.

“A lot has been said about the concept of pricing power, whereby a company has such a strong brand that demand won’t be affected if prices go up. But when you have multiple price increases in short succession, there comes a point when demand might be dampened. It’s fair to say that Greggs has pricing power and could probably push up prices further without hurting demand.

“Yet Greggs is being overly cautious and warning of no material profit growth this year. That is going to be the case for many retailers. In fact, simply managing to match last year’s profit might be turn out to be a good result for retailers in 2022 given the headwinds to earnings.

“Even though the cost pressures and demand risks might seem painful now, Greggs has its eye on the longer-term prize which is having a much bigger business. It is laying the foundations by strengthening its infrastructure to support greater store numbers, longer opening hours and more delivery orders.

“Weaker retailers might halt such investment in trouble times, so the fact Greggs is ploughing ahead says a lot about the resilience of its business.”

These articles are for information purposes only and are not a personal recommendation or advice.