2022 Investment Views: Global quality equity income

As the COVID clouds lift, a clearer picture will emerge

Companies that can handle rising cost pressures and continue to deliver free cash flow growth will be well placed to navigate 2022.

24 Nov 2021

2 minutes

Abrie Pretorius

The fast view

  • As the COVID clouds lift, we should get a clearer picture in terms of the real demand and cost pressures that companies are facing.
  • A key risk is that central banks could be forced to accelerate liquidity withdrawal and the interest rate cycle at a time when we are seeing a rapid deceleration in growth.
  • Investing in businesses that possess intangible assets, can keep up their pace of revenue growth which can pass through to cash flows should help alleviate this risk.
  • Companies that possess strong pricing power but don’t have high capex costs should still deliver strong free cash flow and dividend growth in 2022.
Q US equity markets are at record highs, but does that tell the whole story?

We have gone full circle since the start of COVID about two years ago. If you look at global revenue, it is now about 2% higher than in 2019 but I think the real story is probably about profits, which are up almost 40% compared to 2019. Companies really delivered very strong operating leverage, especially during 2021. This was largely by sectors such as energy, consumer cyclicals and the cyclical areas of tech, where demand returned but without the full extent of their cost bases returning to normal.

So, I think we are now really seeing cost rapid returning, with inflation running hot. So, I think, as we look into 2022, the interesting thing will be that COVID clouds will lift, and we are probably going to start getting a clearer picture in terms of the real demand and cost pressures that companies are facing.

QWhere are the major risks in 2022?

Revenue growth is likely to slow materially as we enter 2022 and the risk is that the costs we are seeing now stay elevated. That is going to force central banks to accelerate liquidity withdrawal and the interest rate cycle at a time when we are seeing a rapid deceleration in growth.

It is free cash flows that drive share prices, not earnings, so we are quite wary of the businesses that have got high reinvestment costs at a time when those costs are elevated. So, we steer more into businesses with strong intangible assets that can deliver strong revenue growth and can have that revenue growth pass through to cash flows. This is possible because they don’t have the high reinvestment requirements as their asset bases are really driven by software, code, patents and brands.

Q Where do you see opportunities next year?

We think that companies with very strong track records of growing dividends are likely to do well. Specifically, we favour the businesses within the consumer, some select software and healthcare spaces. The common theme here is these are companies with a good combination and mix of offence and defence, but they have got capital-light balance sheets as they don’t have high reinvestment requirements. We believe this issue of the cost base increasing rapidly in 2022 may catch some investors off guard as many focus on earnings and not cash flow.

Q What is your investment strategy heading into 2022?

We favour a limited number of businesses that we think will be able to again deliver real dividend growth next year. They possess strong pricing power, which will keep up with the demand environment but don’t have the high reinvestment costs that most other businesses have. Therefore, they should be able to deliver very strong free cash flow growth once again.

We believe 2022 is going to be a year in which quality drives growth. It is important, as we have a lot of different distortions in the market, to be very selective and diversified geographically. Europe, the US and emerging markets have all got very different restrictions that are driven by the local governments and so investors need to be able to identify unique drivers of the individual businesses that can drive growth in 2022.

Authored by

Abrie Pretorius
Portfolio Manager

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