Three defensive stocks for slowing markets

Source: Trustnet

The world feels an uncertain place at present, with investors having to contend with higher prices, war and political instability both at home and abroad.

Keir Starmer is under severe pressure to keep his place as prime minister, with suggestions that the leader of the Labour party could be challenged in the coming days.

This could put investors off the domestic market, but there are worries with international markets too. War in the Middle East between the US/Israel and Iran has caused an oil crisis that has driven prices higher and caused consternation that inflation could rear its head again – adding to the potential of interest rate policy mistakes by central banks.

All of this has culminated in worries over economic growth and heightened market volatility, according to Mark Peden, co-manager of the Aegon Global Equity Income fund.

Stocks that work well when the world is uncertain tend to be defensive in nature, able to grind out growth in a slowing economy.

One example is Linde, the world’s largest industrial gases company, which was formed in 2018 following the merger of Germany’s Linde AG and US firm Praxair.

“It manufactures atmospheric and process gases that are required in a wide variety of industries such as steel, chemicals, energy, electronics and healthcare, as well as providing engineering solutions and decarbonisation technologies,” said Peden.

Three companies now effectively control the gas market, while there is a reliance on “long-term, inflation-linked take or pay contracts”, which make these stocks less sensitive to economic downturns.

Linde also provides “unrivalled cashflow visibility”, making the company a “fantastic defensive compounder”. Indeed, it has beaten earnings-per-share estimates in every quarter since 2018 and has grown its dividend every single year for the past 33 consecutive years, if including the track record of Linde AG.

“Delivering mid-to-high single-digit annual revenue growth, small positive increments to operating margins, an active share buyback programme and a growing dividend, the company is very well placed for investors to enjoy a lower-beta, highly attractive annual total shareholder return regardless of the economic backdrop,” said Peden.

Up next, he highlighted TSMC, the semiconductor giant dominating the emerging market landscape. While technology is not a typically strong place to invest during slowing markets, today “one could argue that many large tech companies have the characteristics that investors look for in defensive stocks”, he said.

These include, but are not limited to, established competitive moats, significant revenue visibility, strong balance sheets and incredibly durable, cash generative business models.

Although the semiconductor industry is “inherently cyclical”, the rise of AI has pushed demand higher and TSMC is established as one of the main players in the industry, able to produce chips that are smaller than competitors.

“At around a 70% share of the global semiconductor foundry market, it is the dominant player. Its technological lead over rivals means this share rises to over 90% for the most advanced chips – a near monopoly,” said Peden, making it “arguably one of the most defensive businesses in the world right now”.

While TSMC is spending significant amounts on capital expenditure, it generates “vast amounts of free cashflow”, which has allowed it to pay a dividend in recent years.

“If you thought the world economy was slowing and you found a company with long-term customer relationships, capacity substantially booked for the next couple of years, a net profit margin in the mid-40s, no net debt and a rapidly increasing dividend, you would be excited,” said Peden.

Staying in the emerging markets, Singapore Telecom was the manager's third selection. A more traditional defensive industry, telecommunications is rarely a discretionary (optional) expenditure, nor is it typically a large part of monthly bills.

“This means telecoms businesses have revenues that are fantastically sticky and visible into the future,” said Peden, who noted that Singapore Telecom is the largest telecom service provider in Singapore and second largest in Australia through its ownership of Optus.

The Aegon Global Equity Income co-manager is not a fan of telecoms companies in general as they can be highly indebted and achieve little growth, but noted that this stock is different, as it has “more exciting growth potential than you get from most European or US telcos”.

With strategic investments in providers across Asia and an IT services arm and a digital infrastructure arm, Singapore Telecom is well diversified. Meanwhile, management has increased returns from its operating companies in recent years and is supportive of shareholders, with a 4% dividend yield looking “well supported”, said Peden.