Consumer prices rose 8.6% in May, according to the Bureau of Labor Statistics, and there's no telling when the increase in prices will stop. Supply chain issues, increased money supply, and low interest rates have fueled inflation, and the worry is that it will be hard to stop.
As investors, one of the best ways to combat inflation is investing in companies that have the pricing power to pass additional costs on to customers, or that may even see inflation as a tailwind. I think Apple (AAPL 0.64%), MGM Resorts International (MGM 0.99%), and Verizon Communications (VZ 2.85%) all have a lot going for them in an inflationary environment.
Apple's pricing power
Companies are going to react to inflation pressure in different ways. Some will reduce spending to lower input costs (restaurants), others will need to eat the added cost because they're in a competitive market (hotels), and others will be able to pass additional costs on to the customers because they have pricing power.
Apple is certainly able to pass costs on to customers because it has a fairly affluent user base and a high price point already. It also has long-term supply contracts that could keep some inflation costs at bay.
The way I think about Apple, the biggest risk is that consumers put off purchases because of higher prices. But Apple has already seen refresh cycles get longer, and there's a limit to how long people will wait to get a new smartphone, especially in the company's affluent target market for new devices.
On top of pricing power, Apple has $192.7 billion in cash and investments on its balance sheet. High inflation has led to rising interest rates, which mean better returns on that cash.
Apple has the balance sheet to withstand the current turmoil and will be able to pass cost increases on to customers, and that's why it's a great stock to own in an inflationary environment.
MGM Resorts may love higher prices
MGM Resorts may be a hidden inflation play because of its high operating leverage. The company spent tens of billions of dollars building or acquiring the casinos it operates on the Las Vegas Strip and around the world, but then it sold most of the underlying real estate to Vici Properties (NYSE: VICI) when interest rates were much lower than they are today, reducing interest rate risk.
Today, the business doesn't have many expansion opportunities because gambling has become saturated in the places where it's legal, so the outlays are limited.
This combination of selling assets when rates were low and having few expansion plans is actually an advantage in an inflationary environment, because any price increases for hotel rooms, food, and gambling will be very high-margin.
Look at the image below to see that MGM's gross margin is relatively high at nearly 50%, but operating margins are lower (in the high single digits) because of relatively high operating expenses. This is because operating costs include items like rent and marketing costs. If the price of hotel rooms, food, and other items goes up, we could see margins rise because of this operating leverage.
MGM Gross Profit Margin (Quarterly) data by YCharts
The downside risk is that MGM will likely be more affected by a recession than Apple or Verizon because a trip to Las Vegas is a discretionary expense. So far, that reduction in revenue hasn't hit MGM hard, but it's a risk to the business that's worth acknowledging because it could offset some of the advantages MGM has in an inflationary environment.
Verizon has become a consumer staple
Verizon may have pricing power in the cellular market, but that's not why it's a great inflation stock. Its advantage is that the spending it did to buy spectrum and build a 5G network, not to mention the debt to fund those expansions, is in the past. And the company has just $13.1 billion in debt maturing in the next year and some debt extending all the way out to 2061.
VZ Total Long Term Debt (Quarterly) data by YCharts
So as inflation increases, the cash margin that Verizon generates should rise, assuming it raises prices even slightly. This could lead to a steady increase in the bottom line, and given rising interest rates, Verizon may even use some cash flow to pay down debt.
Telecommunications stocks aren't normally put in the consumer staples category, but given how reliant modern consumers are on smartphones, I think it's about as stable a business as there is today. Inflation may lead to higher prices for service, but that'll help Verizon's bottom line as well.
Inflation could be a tailwind for some companies
Inflation may not generally be helpful for business or the economy, but for Apple, MGM Resorts, and Verizon it isn't the headwind it will be for some. If the economy doesn't decline sharply, inflation may even be a tailwind for the bottom line. That's why these are companies I would recommend buying if you're worried about inflation getting even worse.
