Loose monetary policy, stimulus checks and a whole host of other measures helped the U.S. get through the 2020 lockdown. However, this “free money” came with a price, which was the highest inflation rate seen since 1981. According to Trading Economics, the annual inflation accelerated to 8.6% in May of 2022, well above the Federal Reserve’s 2% target.
To combat this, the central bank is raising its federal funds rate, which impacts real interest rates. Higher interest rates raise the cost of borrowing for households and thus can impact household income. While high inflation squeezes both consumers and businesses with higher input and utility costs, it is manageable when we have a “high growth” scenario. However, if gross domestic product growth is negative or low and inflation is high, this causes “stagflation”.
According to a recent study by Wells Fargo (WFC, Financial), the bank's investment institute saw a second-quarter GDP contraction. Thus with inflation rates high, we now are in a stagflation scenario. Analysts from Nomura also forecast a “shallow but long recession” starting in the fourth quarter of 2022. During historical inflation periods such as the 1970s, both real estate and commodities performed well. Companies with “pricing power” can also do well.
Let’s dive into my top two stocks to fight inflation.
Energy Transfer
Energy Transfer LP (ET, Financial) is the backbone of the U.S. oil industry. It owns over 120,000 miles of pipeline and energy infrastructure across 41 states and enables the transportation of oil and gas. According to the company’s website, at least one third of all U.S. crude oil and natural gas is transported through its pipelines.
Energy security is a growing concern for nations around the world and with oil prices close to $100 per barrel, companies involved in the industry are seeing profits surge. Whether we have a recession, stagflation or even a war, we will always require energy for our homes and factories. The vast scale of Energy Transfer gives it a competitive advantage as building out a competing pipeline would be extremely costly, take many years and, in many cases, not even possible due to regulations.
In the fourth quarter of 2021, Energy Transfer merged with Enable Midstream Partners to further expand operations. In the first quarter of 2022, the company scored an impressive partnership with China Gas in order to supply the energy giant with liquefied natural gas. The 25-year contract effectively guarantees income for Energy Transfer for the decades to come.
Guru investors Ken Fisher (Trades, Portfolio) and First Pacific Advisors (Trades, Portfolio) were buying shares in the first quarter of 2022 at an average price of $9, which is close to where the stock trades today.
Stable financials
Energy Transfer reported net income of $1.3 billion attributable to partners, which was up 30% over the prior quarter, but down when compared to March 2021. The decline year over year was driven by higher-than-normal revenue in 2021 due to Winter Storm Uri, thus the financials are strong.
Adjusted Ebitda was $3.34 billion for the first quarter, which was less than the $5.04 billion reported in the prior-year quarter, again due to abnormally high earnings from the storm. Management showed confidence and increased guidance for adjusted Ebitda for full-year 2022 to between $12.2 billion and $12.6 billion, up from the $11.8 billion to $12.2 billion stated previously. Free cash flow per share was 52 cents, up from 30 cents in the prior quarter. Distrbutable cash flow was a healthy $2 billion.
Energy Transfer pays a tremendous forward dividend yield of approximately 8% with a 64% payout ratio. Management has announced an expected increase in capital expenditures to a range of $1.8 billion to $2.1 billion, up from the $1.6 billion to $1.9 billion previously announced. In terms of valuation, the GF Value Line indicates a $10 per share value, thus the stock is fairly valued as of the time of writing based on historical ratios, past financial performance and future earnings projections.
American Tower
American Tower Corp. (AMT, Financial) is a real estate investment trust that owns telecommunications assets, such as network towers and base stations. It currently has over 200,000 telecom sites globally, which it builds and leases to large mobile carriers such as Verizon (VZ, Financial) and AT&T(T, Financial). It is ranked 410 on the Fortune 500 and is truly a mammoth of the industry.
Mobile data has become as valuable as electricity to many people. In North America, the average monthly mobile data usage per phone was 15 gigabytes as of 2021. According to Ericsson, this is forecasted to increase by 3.4 times to 52GB by 2027. This is expected to be driven by increased 5G network coverage, video-based apps, augmented reality and much more. 5G subscription penetration is forecasted to cover 90% of North American by 2027.
American Tower is the backbone of the telecommunications industry and still expanding. In the first quarter of 2022, the company completed construction of 1,450 new sites with average day-one yields of around 14%, which is fantastic.
Recession protection
American Tower offers more security for investors with a series of master lease agreements with carriers, which can be up to 15 years. This means recession or not, these leases and agreements are in place. The world's largest hedge fund, Ray Dalio (Trades, Portfolio)'s Bridgewater Associates, and growth stock investing firm Baillie Gifford (Trades, Portfolio) were buying shares in the first quarter of 2021 at an average price of $243 each. This is close to where the stock trades today after the recent pullback.
Financials
American Tower had a strong first quarter of 2022, with property revenue jumping 22%, from $2.1 billion to $2.6 billion year over year. Organic tenant billings growth popped by 18.8% in Europe and 7.4% internationally. The U.S. market did take a hit after the merger of T-Mobile (TMUS, Financial) and Sprint.
Adjusted Ebitda grew 12.8%, from $1.4 billion to $1.6 billion, in the first quarter of 2022. Adjusted funds from operations, a common metric for analyzing REITs, increased by 6.1% to $1.2 billion.
American Tower even raised its property revenue outlook for fiscal 2022. Management expects $10.4 billion, up 14% from 2021.
The REIT's dividend yield is 2.24%. In terms of valuation, the GF Value Line indicates the fair value is around $295 per share. The stock is currently trading at near $255 and thus is modestly undervalued.
Final thoughts
Investing during a recession or stagflation can be a challenge. Ideally, it is best to invest in companies with inflation-proof assets such as oil or real estate in addition to those with stable cash flows, high dividends and a competitive advantage. In this case, these two stocks offer diversification, value and income.
