With crude oil prices sharply rising over the last few weeks and inflation hitting a 40-year high, it's no wonder why people are starting to talk about the prospect of stagflation. In a nutshell, stagflation is an economic malady in which an economy's growth rate is slow or negative, typically as a result of a supply shock like higher energy prices, while also suffering from a high inflation rate (and often high unemployment) at the same time. Sound familiar?
While there's no guarantee that the U.S. economy will slip into or remain in a state of stagflation, it behooves you to figure out how to protect your portfolio from it if it does happen. In this vein, today I'll be proposing two growth stocks that should be able to avoid the worst of any stagflationary impacts, and I'll also explain what makes them resilient.
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1. Alexandria Real Estate
Alexandria Real Estate (ARE -1.96%) is a real estate investment trust (REIT) that caters exclusively to companies engaged in biomedical research. It purchases and builds out biomedical laboratory space, then rents it to some of the top competitors in the industry, like Moderna, Pfizer, and others. And with its total return rising by 21.1% over the last 12 months compared to the market's rise of 10.8%, it's definitely an aspiring growth stock.
Alexandria's current group of tenants provided it with $2.1 billion in trailing 12-month revenue, and defaults on rent are unlikely due to the fact that many of those tenants are massive and mature businesses. Because its productive capital is real estate, exposure to rising energy prices is minimal, at least for its existing properties. Over the last 10 years, its annual cost of goods sold (COGS) as a percentage of revenue has fallen, and its yearly free cash flow (FCF) has risen by 230.6%.
More importantly, Alexandria can simply raise the rent if its costs rise for any reason, as it currently does on an annual basis for 95% of its tenants. Plus, its tenants have a weighted average remaining lease term of 10.9 years, so they won't be going anywhere anytime soon. Likewise, the company's occupancy rate of 94% means that there's minimal risk of a significant amount of space going unused, even if poor economic conditions make it hard to find new tenants.
In sum, there's no obvious way that stagflation could hurt Alexandria's business.
2. Vertex Pharmaceuticals
Vertex Pharmaceuticals (VRTX -0.76%) is a drug developer that focuses on making therapies for cystic fibrosis (CF) and other hereditary illnesses. With four CF drugs for sale and a market cap over $61 billion, the company is by far the largest and most powerful competitor in its niche, and patients don't necessarily have any alternatives.
In the context of stagflation, Vertex has a significant advantage, which it shares with other biopharma companies. Developing new medicines is expensive, but once they are ready for commercialization, they don't actually cost that much to manufacture per unit. Vertex's research and development costs account for 40.2% of its annual revenue, but its cost of goods sold is only 11.9% of its annual revenue.
In other words, bringing in $7.5 billion during 2021 only required spending $904 million in COGS. And regardless of the ongoing economic conditions, management expects to make as much as $8.6 billion in revenue from sales of its drugs this year, so growth remains strong.
While it's true that the materials needed to conduct research or manufacture drugs may rise in price due to higher energy costs or inflation, Vertex has pricing power over its medications, which can mitigate the impact of both.
Newly released drugs are typically priced so as to help recoup the development costs as well as production costs, and the situation under stagflation would be no different. And, its stock can still realize significant boosts from reports of progress in its clinical trials regardless of the economic environment. Hiking prices on older medications is also an option, though doing so would be morally hazardous given that CF patients don't have any other choice for treatment.
Finally, it's important to remember that some of the company's key activities are largely insulated from economic conditions altogether. Preparing regulatory filings to get medicines approved for sale involves labor costs and administrative fees, but if the stagflation features high unemployment, it won't be hard to retain the appropriate personnel at an acceptable price. And that's favorable for investors looking to hedge against stagflation, to say the least.
