Inflation: Rotten to the Core

Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you believe, as I do, that inflation is in our near future, investors beware! To succeed in an inflationary environment, investors must carefully choose the companies in which they place their hard-earned money. If chosen properly, investors are at the very least able to maintain their purchasing power, whereas poorly chosen companies will simply eat away at your nest egg. Let’s look at two companies that may face tough headwinds in an inflationary environment, as well as two companies that should carry on just fine.

Apple (NASDAQ: AAPL) is the first company that I believe will see its core begin to rot in an inflationary environment. Apple enjoys massive profits in the higher-end spectrum of the personal computer, tablet, and smart phone markets. Despite the Great Recession and high unemployment, consumers have continued to purchase these high-priced electronics. Unfortunately, computers and airline tickets have something in common: their prices have been in a long-term decline. In an inflationary environment of 6%-8% per year, I believe Apple will find it quite difficult to pass its increased costs on to its consumers. That leaves it with three options, two of which are bad news for the business: (a) raise prices to keep up with inflation and potentially price itself out of consumers wallets, (b) keep prices steady or increase slower than inflation and have smaller margins, or (c) find a way to make their input costs less than they are today. As you can see, only the last option helps the business, but the company would already be doing that if it were possible today.

Next up, we have Chipotle Mexican Grill (NYSE: CMG). The restaurant industry is particularly sensitive to inflation, but I believe Chipolte is a bit worse off than the average restaurant. Positioning itself above fast food but below expensive sit-down restaurants, Chipotle has dominated the fast-casual food arena for the last few years. Despite the Great Recession, the company was able to continue its expansion and boast large same-store sales numbers quarter after quarter. I think it is the company’s position in the fast-casual segment that may cause it more damage than the average fast-food restaurant if/when inflation sets in.

In order to maintain its margins, Chipotle would need to pass on all of its increased costs onto its customers or find other ways to reduce its input costs. Unfortunately for Chipotle, that may be difficult, due to its position in the restaurant field. If it raises its prices too quickly, it risks pricing itself out of the fast-casual food category. If it doesn’t raise prices fast enough, it quickly see its margins deteriorate. Unlike Buffalo Wild Wings, customers do not eat at Chipotle for its environment. Although inflation would negatively affect the wing-slinging Buffalo Wild Wings, the sports-lover environment, as well as some tasty beer, may be enough to keep its patrons coming.

Although passing increased costs on to the costumer is never painless, some companies have an easier time than others. Low-dollar amount every day purchases can see their prices rise on par with inflation and not see decreased demand. A good example of this can be seen in Coca-Cola (NYSE: KO) and its product line of sodas, waters, and herbal teas. A two-liter bottle of Coke priced at $2.60 can be increased to $2.80 and probably would not see a decrease in demand, despite a 10% increase in cost. The key to passing on costs is to have a product that a consumer buys on a regular basis and either does not notice the increase or does not feel the impact enough to stop buying the product. The sticker shock of a 10% increase on an Apple product might be enough to keep the customer from making the purchase.

While consumers may eventually pass on Coke products if the price rises too high, there are companies which sell products that cannot be so easily passed over. Take DaVita HealthCare Partners (NYSE: DVA) as an example. DaVita offers dialysis services for patients who suffer from kidney failure. Unlike a bottle of Coca-Cola, one cannot simply pass on dialysis services if they are needed. The necessity of its products is what will allow DaVita to fully pass on any increased costs that it may experience if inflation were to pick up in the future.

Macro-economic issues are difficult to predict. Even if one fully believes that inflation is coming, no one can predict the actual timing of its arrival. For an investment to be intelligent, it must, in the end, provide us with the same purchasing power plus an acceptable rate of return for making the investment. It is for that reason that I chose Coca-Cola and DaVita, as I believe these two companies can do well in both normal environments and inflationary environments. Prepare your wallets and pocketbooks because inflation is coming--it is just a question of when!

RoyalScribe owns shares of Chipotle Mexican Grill and Coca-Cola. The Motley Fool recommends Apple, Chipotle Mexican Grill, and Coca-Cola. The Motley Fool owns shares of Apple and Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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