Trading Strategies: one of UK’s biggest firms tipped to keep growing

The first US interest rate cut since March 2020 has prompted a degree of excitement among investors. Not only was it a 50 basis point reduction, as opposed to an expected 25 basis point cut, it was complemented by revisions to the Federal Reserve’s projections regarding monetary policy and inflation.

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The central bank now expects interest rates to fall at a substantially faster pace than previously forecast. While it estimated in June that they would decline to 5.1% this year, 4.1% in 2025 and 3.1% in 2026, the Fed now forecasts a decline to 4.4%, 3.4% and 2.9% over the same period.

These changes have partly been prompted by revised inflation expectations. The central bank now anticipates that inflation, which is still currently 50 basis points above its 2% target, will fall to 2.3% this year versus a previous forecast of 2.6%. It then expects it to decline to 2.1% in 2025 compared with a previous forecast of 2.3% before falling to 2% in 2026, as per its June estimate.

Long-term change?

All of the above forecasts mean that the Fed plans to adopt a more aggressive stance than previously envisaged when seeking to unwind its restrictive monetary policy. While this could reduce the prospect of an economic slowdown or even a recession over the medium term, ultimately it may not represent a sea change in the long-term outlook for globally-focused companies.

Indeed, the Federal Reserve still expects inflation to meet its 2% target within the same two-year timeframe as it did in June. And while it now intends to ease monetary policy at a faster, it anticipates that terminal interest rates - the target for a cycle of rate adjustments - will be 2.9% versus a figure of 2.8% in its June forecast. Therefore, the long-term prospects for cyclical stocks may not be vastly different as a result of the central bank’s revised expectations.

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Furthermore, the Federal Reserve still lacks control over short-term prospects for the US economy due to the existence of time lags. Even its 50 basis point cut will take many months to have an impact on economic data. Therefore, it may not materially affect the chances of a recession in the near term.

Investment opportunities

While investors should not become overly excited about the Fed’s revised estimates or its larger-than-expected rate cut, the central bank’s increasingly dovish stance is still set to prompt improved operating conditions for global consumer stocks.

As well as boosting the US economy’s performance, which is a key market for many such firms, falling borrowing costs should have a positive impact on the world economy. Notably, lower rates are set to provide a positive catalyst for emerging economies as their debt, which is often priced in US dollars, becomes cheaper.

When combined with a period of modest inflation, lower interest rates that prompt an improving global economic outlook should ultimately equate to greater purchasing power for consumers. This may mean an end to cost-of-living difficulties that have plagued consumers over recent years and, in some cases, have caused them to trade down from branded products to cheaper substitutes.

And with lower inflation set to put less pressure on input costs, consumer goods companies are likely to find the task of growing profit margins much easier in future than they have in the past. This should boost their financial performance after a rather difficult period.

A patient approach

Of course, interest rate forecasts and inflation expectations are continually subject to change. With geopolitical, as well as economic, risks likely to remain elevated over the coming months as the US presidential election takes place, the near-term outlook for global consumer goods firms could prove to be somewhat challenging. Indeed, it would be unsurprising for their share prices to display significant volatility in the short run.

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However, investors who take a long-term view and are patient enough to wait for the full impact of an era of lower inflation and interest rate cuts to be felt are likely to be well-rewarded. Therefore, now could prove to be an opportune moment to purchase high-quality consumer goods companies.

Growth potential

Past performance is not a guide to future performance.

Unilever (LSE:ULVR) should be a major beneficiary of a new era of modest inflation and monetary policy easing. The FTSE 100 consumer goods business, which owns popular brands such as Lynx, Hellmann’s and Dove, is exposed to a diverse range of economies that are poised to experience improved performance.

Notably, around 58% of its sales are generated in emerging markets. They should benefit from lower debt servicing costs as US interest rates fall. And with 22% of the company’s revenue being generated in North America, its sales are set to be catalysed by an improving outlook for US consumers as cost-of-living challenges gradually fade.

A sound strategy

The company, of course, is already delivering a solid financial performance. In the first half of its financial year, for example, sales growth amounted to 4.1%, with operating profits rising by 17.1% as a result of improved profit margins. They increased by 250 basis points to 19.6% at the operating level as the firm’s productivity programme gathered pace.

This is being undertaken alongside a separation of the company’s ice cream segment, which is due to be completed next year. Given that it produced sales growth of just 0.6% in the first half of the year, thereby making it the firm’s worst-performing segment by some distance, its disposal will allow the business to focus to a greater extent on brands that offer superior growth potential. Indeed, its largest brands, which account for roughly 75% of its turnover, generated sales growth of 5.7% during the first half of the year.

Risk management

Having risen by 26% since the start of the year, versus a 7% gain for the FTSE 100 index, the company’s shares now trade on a forward price/earnings (PE) ratio of 20.1. Although this figure suggests that there is limited scope for an upward rerating, a combination of stronger sales growth amid an improving operating environment and the positive effects of the firm’s strategy are set to catalyse its earnings growth. This means that the stock merits its premium valuation compared with the wider FTSE 100 and continues to offer capital growth potential.

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Unilever also deserves a relatively rich rating due to its lower risks vis-à-vis other FTSE 100 stocks. Its diverse range of brands, which includes discretionary and staple items from a variety of market segments, are sold across a broad range of geographies. The loyalty they command among consumers means that while some customers traded down to cheaper substitutes during the recent bout of high inflation, the company’s stable of brands nevertheless provides a relatively wide economic moat that equates to a more favourable risk/reward opportunity.

Investment appeal

The company’s solid financial position further reduces overall risk for investors. Although its net debt-to-equity ratio of 123% is relatively high, the company’s net interest cover amounted to around 20 in its latest financial year. This shows that it is well placed to overcome any temporary decline in profits as interest rate cuts take time to have their desired impact on the economy’s growth rate.

Overall, Unilever appears to offer a favourable long-term investment outlook. Improving operating conditions amid interest rate cuts and falling inflation, as well as a sound strategy that should boost profitability, mean the stock has the potential to deliver further capital growth following its recent rise.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.