Consumer goods companies are wrestling with the prospects of higher supply chain costs in the near term, stemming from increasing transportation costs. This could affect what consumers pay for everyday items, such as their morning coffee at Starbucks (SBUX -1.88%). In June, U.S. consumer prices rose at the highest rate in 13 years. The latest consumer price index report for July showed a moderation in the rate of increase, but the 5.4% increase in price for all items on an annualized basis is still well above normal.
Whether we are witnessing a temporary or more structural increase in consumer prices, it's a good idea to think about investing in companies that have strong brands and pricing power. Not only does it help keep margins firm with costs on the rise, but it's also a sign of a great business with a durable competitive advantage -- a trait that every investor should look for when investing in stocks for the long term.
1. Starbucks: Increasing order value at checkout
Rising cost inflation is a top concern for restaurants in the near term, but Starbucks has incredible brand power that allows it to maintain demand levels even as it raises prices for fancy coffees. Its momentum accelerated in the last quarter, with comparable same-store sales up 10% on a two-year basis.
"[O]ur internal research also confirms Starbucks has gained meaningful market share in the U.S., and the momentum we have created is sustainable," CEO Kevin Johnson said during the fiscal 2021 third-quarter earnings call.
While the top coffee chain can get away with charging more for its premium menu items, Starbucks has other levers at its disposal to mitigate the threat of higher supply chain costs.
Management is looking to drive higher average spending per customer by offering more customization and promoting cold beverages that sell at higher prices than a standard beverage. Management is also promoting sales of food with a beverage to drive higher average ticket value.
Even with the threat of rising inflation in the near term, Johnson sees further margin expansion from these efforts. Company guidance now calls for full-year comp store sales to be up 20% to 21%. Most importantly, Starbucks should have a non-GAAP operating margin of 18%, which would be an improvement over fiscal 2019's 17.2%, and this is with the expectation of higher input costs, investments in growth initiatives, and higher wages for employees.
Starbucks is one of the top brands in the world and is a great stock to anchor anyone's portfolio.
2. Levi Strauss: Surging demand for denim
Levi's is one of the most iconic apparel brands in the world. The business was hit hard by the pandemic, but it's making a comeback. Traffic to stores has been increasing, allowing average unit revenues to firm up. Management reported seeing better full-price sell-through in the most recent quarter.
"Demand for our brands remains strong globally," CEO Chip Bergh said during the fiscal 2021 second-quarter earnings call. "Our men's bottoms business continues to gain traction and has nearly returned to pre-pandemic levels. And our women's bottoms business has now exceeded Q2 2019 revenue, up 9%."
Despite cost inflation, Levi's saw improvement in gross profit margin in the quarter, driven by reducing promotional sales programs through wholesale and higher market share gains in denim bottoms.
"It is also pertinent to note that even after the price increases we have taken, both in the past and for the second half of 2021, we still have pricing power to not only offset cost inflation, but to also improve our gross margins as well," Bergh said. Bergh added that Levi's has negotiated most of its product costs through the first half of 2022 at very low single-digit inflation rates.
Management's guidance calls for revenue growth in the second half of fiscal 2021 of 4% to 5% over the second half of fiscal 2019 and 28% to 29% over fiscal 2020. At a below-average forward price-to-earnings ratio of 20.7, this top denim brand looks like a great deal.
3. Lululemon: Customers pay up for quality
Lululemon is another top retail brand that can withstand higher inflation. Its focus on product quality and solving specific needs of those who live the "sweat life" has driven impressive growth in recent years. But what doesn't get much attention with Lululemon is its incredibly high operating margin for an apparel store.
Lululemon's trailing 12-month operating margin was 20.4%, which is higher than Levi's 9.9% and Nike's 15.6%. These numbers show that Lululemon is standing out in a competitive industry because of its distinctive brand, which gives it plenty of price elasticity to weather cost pressures.
Innovation has allowed the company extra freedom to raise prices in the past, which will likely serve it well in the current environment. Management has found that the more features and innovation they put into a product, the higher the price guests are willing to pay, which speaks to why the business generates such high margins for an apparel brand.
Lululemon posted revenue growth of 25% on a two-year basis in the most recent quarter. Guests are showing a strong response this year to Lululemon's On the Move assortment, in addition to Mirror, the maker of interactive fitness devices that Lululemon acquired last year.
Most importantly, management expects gross margin to expand between 1.5 to 2 percentage points this year. This includes the effect from higher freight costs, which the company is also offsetting with robust growth in the higher-margin e-commerce channel.
All three stocks -- Starbucks, Levi's, and Lululemon -- have the brand power to raise prices on products to keep up with inflation rates and deliver market-beating returns to investors.