A year ago, the activation of the NordStream2 pipeline was still waiting for final approval from the German government, delayed by concerns about its implications for Europe’s energy independence. The Russian invasion of the Ukraine six months ago made these concerns a reality, and since then European natural gas prices have risen close to 600% and are now 10 times higher than the 10-year average. The prospect of Russia cutting supply to Europe this winter means energy rationing and factory stoppages are not unrealistic. But the increase in prices have affected global benchmarks, meaning countries who use little Russian gas, such as the UK, are facing soaring energy costs too.
While Europeans are hoping for a mild winter, the hot summer has brought the worst drought on the continent in 500 years. Low river levels have meant that coal cannot reach German power stations, and that water is too warm to act as a coolant for French nuclear ones. This has put even further pressure on energy prices. The squeeze on consumers and businesses from these higher energy costs, mean that despite the first full European summer holiday season since 2019, the likelihood of recession in Europe is high. Yet that is not to say that select European companies cannot offer a port in the coming storm, and indeed have a powerful role to play in the Endeavour Fund.
The energy crisis has heightened Europe’s need to transition to renewable sources of energy. Iberdrola, the Spanish utility company generates 80% of its power from renewables, and in July it switched on Europe’s largest solar power plant. The plant will produce sufficient energy for 335,000 homes and cost €300 million, a small part of €14.3 billion that the company has earmarked for other wind and solar farms by 2025. Despite the renewed use of coal elsewhere in Europe as an emergency measure, the accelerated energy transition will create a strong tailwind for Iberdrola. Likewise for Alfen, a leading provider of EV charging networks and smart grids in Europe that is growing at an annualised rate of almost 40% in the medium-term.
Unsurprisingly, the vertiginous rise in the natural gas price has benefitted producers, such as Shell who, through production and trading, handle 20% of the world’s liquified natural gas market. A fall in demand for oil due to economic slowdown, and the possibility of Iranian supply coming online, could see oil prices move lower. But natural gas makes up approximately a third of Shell’s profits, and the shares will act as a useful hedge if Putin does cut off Europe’s gas.
Recession risks and high energy costs should have limited impact on the healthcare sector. The Endeavour Fund’s largest shareholding is AstraZeneca, and six months ago I highlighted the company’s superior return profile of 20% annualised earnings growth over the next three years driven by a number of successful drug launches in recent years, particularly in oncology, and the boost to margins from the acquisition of Alexion; but the shares traded at the same valuation as the market, which offered half the level of growth (astrazeneca-not-getting-credit/). The shares have returned 30% since then and now sit at a small premium to the market, but that earnings profile should become even more attractive as growth becomes scarcer.
Consumer goods companies are obviously vulnerable should we face a recession caused by a slowdown in people’s spending. Yet at the opposing ends of the consumer spectrum are companies that offer a relative haven in a downturn.
Consumer staples companies need to pass their rising input costs on to customers – this is easier to do if your brand is strong and in a category that people are unwilling to sacrifice. No surprise then that Purina Petfood was Nestle’s largest contributor to organic growth in the first half of the year.
Luxury goods companies, meanwhile, have two strengths: their typical customer and their margins. Both are less sensitive to economic slowdown and cost inflation than other consumer companies. While a recession is not good news for LVMH, they should do relatively better than other consumer goods companies.
Diageo straddles both ends of the spectrum without being caught in the middle. While not an essential, its spirits brands can benefit from in-home consumption should spending in bars and restaurants decrease; while its premiumisation strategy means that much of its growth is coming from those consumers less sensitive to a slowdown.
An additional strength for European companies like AstraZeneca, Nestle, Diageo and LVMH is they earn much of their revenues in US Dollars. Despite already being at multi-decade highs, the Dollar should strengthen further against the Euro and Sterling in the event of a recession in Europe this winter, giving a further boost to these companies’ earnings.
UK and European companies undoubtedly face a tough time this winter; but there are some that can offer exposure to strong and robust growth, defensiveness, and cyclicality, to help the Endeavour Fund navigate the turbulent seas ahead.
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