Winter (I mean inflation) is coming. Indeed, it’s already here and it might as well be winter in true Game of Thrones fashion that business is about to become just a little harder for FTSE 100 companies. As its response to rising prices, the Bank of England is expected to raise interest rates. Simply put, due to the pandemic, which was the greatest threat to the global financial system since the crisis of 2008, the central banks of the world had to find ways to stimulate their economies.
Interest rates in brief
In order to stem the tide of the economic fallout last year, governments dropped interest rates. The Bank of England base rate – or simply ‘the interest rate’ – is the interest rate that lending banks can charge to other financial institutions. Generally speaking, central banks lower this rate when economic activity is staggering (which has the effect of making access to money cheaper for both institutions and individuals) and raise it when the economy is overheating and inflation is running higher than the annual target, which makes it more expensive for banks and businesses to borrow… which isn’t the greatest news for the FTSE 100.
Businesses like cheap money and indeed they need it in difficult times. According to the Financial Times, traders are expecting a rise from the current rate of 0.1% to 0.25% on the 3rd of November this year and all the way to a full 1% by August of 2022. As interest rates rise and the cost of borrowing becomes higher, most businesses and individuals must cut their spending and thus earnings and share prices will generally drop. There is, however, one stock that I believe will likely continue to do well despite these increases.
The FTSE 100 stock I believe is best poised to beat the rise
The average person is familiar with brands such as Johnnie Walker blended scotch, Smirnoff vodka, Crown Royal Canadian whiskey, Captain Morgan rum, Tanqueray gin, Baileys Irish Cream, and Guinness stout. These liquors are varied but regardless of one’s taste in alcohol, what they all have in common is that they are owned by Diageo (LSE:DGE). Diageo is well poised to do well in this inflationary/ higher interest rate situation because not only do its financials show superior earnings power but, due to its status as a producer of consumables, it can simply pass on the costs of doing business to its consumers. The brands named above are internationally recognised and if the prohibition era in the USA is anything to go by, alcohol is the perfect balance between a luxury good and a consumer staple.
The downside to this business is potential supply chain interruptions. Currently, there is a bottle shortage, particularly in the USA, which could affect the ability of this business to function optimally in the short term, but in the long term this is a stock that pays a respectable dividend, has been growing its free cash flow, is well managed and has as its moat several internationally acclaimed brands. All this and the fact that changes to sustainability practices are unlikely to affect the way that people consume alcohol is why I’m bullish on Diageo long term and would consider adding it to my portfolio.