This morning (26 March) UK inflation data for February came out. It revealed a surprise fall from 3% last month to 2.8%, giving a boost to the FTSE 100 and FTSE 250 in the morning. Yet this data and the implications will cause different reactions for some sectors and FTSE stocks. Here is one that I think could do well, alongside one that could struggle.
Boosting profit margins
Tesco (LSE:TSCO) is one company that could really benefit from inflation trending back lower in coming months. One of the key components that goes into the consumer price index for inflation is groceries and other everyday goods that Tesco stock. The store’s customers are sensitive to rising prices. As a result, when inflation is very high, Tesco experiences lower demand. This was something that we saw during 2022, when it climbed above 10%.
On the other hand, part of the 12% share price rally in the last year has come as inflation has shown signs of being back under control. The 2024 annual results mentioned how the net concern about inflation from customers is now down to 50% from 70% at the start of the
year.
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From a financial perspective, the report spoke about a focus on growing absolute profits while maintaining margins. One way it’s seeking to do this is by “targeting productivity initiatives that at least offset inflation in the medium term”. This shows me that the business has learnt from the problems caused by rising prices back in 2022 and is taking steps to address this in case inflation rises in coming years.
One risk is the tough competition in this sector. Supermarket chains have thin profit margins at the best of times, so any cost increase could flip the business from a profit to loss.
Pressure on pricing
National Grid (LSE:NG) is a firm that could struggle with low inflation. This might sound odd, but hear me out. As an energy utility company, National Grid’s revenues are often linked to inflation through regulated price controls. Lower inflation can lead to reduced allowable price increases, potentially impacting revenue growth and profitability.
Back when inflation was surging in 2022, energy companies like National Grid came under pressure from some who believed the businesses made excess profits as part of passing the higher costs onto customers. This wasn’t illegal and was within the Ofgem price control frameworks. But it certainly helped National Grid financially.
The flipside could also be true if inflation keeps falling. Without much wiggle room on price increases, National Grid could see revenue stagnate. Of course, a risk to this pessimistic view is that revenue could grow organically. If the business can enjoy a successful marketing campaign or customer acquisition push, revenue could grow that way instead.
The stock is down a modest 2% in the past year, with a dividend yield of 5.84%.
On balance, I’m staying away from National Grid right now but feel investors might want to consider Tesco stock as an inflation idea for a portfolio.
