There is nothing like a recession to weed out weak companies.
For far too long, many businesses had assumed that easy money was a constant and they did not need to maintain sound finances. Similarly, too many companies that lacked a competitive advantage had been able to survive thanks to favourable monetary and fiscal policies that are now quickly coming to an end.
For investors, the key focus in today’s deteriorating economic environment should be on owning financially sound businesses that can survive weaker trading conditions. They must also ensure that their holdings have a clear competitive advantage over their rivals. Stocks that lack one or both of these attributes should, in Questor’s view, be avoided.
Fortunately, Big Yellow, which was tipped as a buy in this column in December 2018, scores highly in both areas. The self-storage specialist’s half-year results, released last week, showed that it had the financial standing to navigate the current cost of living crisis and wider economic slowdown.
Its debt-to-equity ratio currently stands at around 23pc and its policy of ensuring that half of all borrowings are at a fixed rate is likely to prove beneficial in the current period of interest rate rises. Its average cost of debt stands at 4pc, while underlying interest cover of 8 in the first half of the year shows that it can comfortably cope with the end of easy money.
The company’s like-for-like store revenues increased by 8pc in the first half of the year; higher rents were the main catalyst.
Its overall store operating margin also increased during the period by 1.3 percentage points to 72pc. It was aided by its ability to limit rises in store operating expenses to just 4pc despite high inflation.
While uncertain operating conditions are undoubtedly ahead, Big Yellow has a strong competitive position owing to its focus on London and nearby commuter towns. High competition for land means there is a lack of new entrants and a very limited supply of new self-storage space. In addition, the company’s investment in its digital platform differentiates its offering from rivals and further widens its economic defences.
Trading on a price-to-book ratio of 0.9 and yielding 3.8pc from a dividend that was raised by 8pc in the first half of the year, the company’s shares continue to offer good value for money. They have risen by 27pc since we first advised readers to buy them; this represents a 17 percentage point outperformance of the FTSE 100.
In the short run, we do not expect stunning returns in view of the economy’s slowdown. But with the financial strength to survive and a competitive advantage that is likely to grow as weaker rivals struggle, the stock offers further capital return potential over the coming years. Hold.
Questor says: hold
Share price at close: £11.19
Another previous buy recommendation, Relx is also in a strong position to deliver further capital growth. Shares in the analytics specialist, which provides data to businesses, healthcare professionals and governments, have risen by 54pc since they were first tipped by this column in February 2018. In doing so, they have outperformed the FTSE 100 by 53 percentage points.
The company’s latest quarterly trading update said it was on track to deliver full-year underlying sales and profit growth above historical levels. It continues to be extremely profitable and its return on equity of 55pc last year highlights the scale of its competitive advantage. Meanwhile, interest cover of 13 times in 2021 confirms its capacity to cope with the rapid rises in interest rates that may compromise the outlook for other companies.
As a high-quality business, it is unsurprising that Relx trades on a premium valuation. Its forecast price-to-earnings ratio stands at 23 at a time when many large and medium-sized companies trade at rock-bottom prices. But with excellent long-term growth prospects as the world economy ultimately recovers, it remains a worthwhile holding.
Questor says: hold
Share price at close: £23.25
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