The performance of leisure stocks—such as those in the hotel, casino, and restaurant industries—is often tied to the health of the economy, and Fidelity’s Kevin Francfort has prioritized inflation-resistant leisure businesses that he believes can achieve outsized capital appreciation, regardless of the macroeconomic environment.
“Some investors might be surprised to learn that a number of leisure stocks can perform well in an inflationary backdrop,” says Francfort, co-manager of Fidelity® Select Leisure Portfolio (FDLSX), along with Will Hilkert. “Will and I see a wide range of outcomes for inflation over the next few years.”
In managing the fund, Francfort and Hilkert have invested heavily in franchisors, especially among hotels and restaurants. Francfort says these companies tend to run very high-margin, high-return businesses, and experience minimal cost pressure because they do not directly operate the restaurants/hotels. Rather, they sell franchisees the intellectual property and collect a recurring royalty fee.
The stocks of franchisors were well-represented in the portfolio as of October 31, with hotel giants Marriott International (MAR) and Hilton Worldwide Holdings (HLT) among its biggest holdings, along with Domino’s Pizza (DPZ) and Restaurant Brands International (QSR)—owner of Burger King, Tim Hortons, and other fast-casual chains.
“Because franchisors tend to be less sensitive to inflationary pressure, they’ve held up relatively well amid this backdrop of high inflation and rapidly rising interest rates,” says Francfort.
Separately, Francfort says he and Hilkert are taking a close look at the type of debt a company holds.
“Fixed- versus floating-rate debt, as well as the timeframe for a firm to refinance its fixed debt, are becoming increasingly important investment qualities to us,” states Francfort. “Among stocks with a similar valuation, we have a strong preference for companies with fixed, long-term debt, which isn’t negatively impacted by the upward trajectory of interest rates.”
Another strategy the co-managers have pursued is to invest in companies with fixed expenses and variable revenue. For example, a company with fixed-rate property leases can be shielded from higher costs over a multiyear period, they say.
Casino operator Penn Entertainment (PENN) is an example of a fund holding that has the combination of variable revenue and fixed costs the co-managers prefer. They recently increased exposure to Penn, bringing the position closer to a neutral weighting versus the industry benchmark as of October 31.
“Variable revenue and relatively fixed costs are beneficial during an inflationary environment because, over time, companies whose revenue is tied to nominal gross domestic product and disposable income will see profit margin expansion as revenue grows faster than costs,” says Francfort.
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