Forget trying to guess when inflation will fall – just stick with high-quality stocks instead

Trying to predict when inflation will return to the Bank of England’s 2pc target is a fool’s errand. 

The central bank itself has been repeatedly wrong on inflation, with last month’s 10.1pc figure being 0.4 percentage points higher than its first quarter forecast.

In Questor’s view, recent interest rate rises are likely to ultimately prompt a significant fall in the rate of inflation. When that happens, and when inflation will return to the Bank of England’s target, is a known unknown. 

However, a lower rate of inflation over the long run is likely to ultimately encourage a more dovish monetary policy that benefits equities, such as WH Smith, that are held in our Wealth Preserver portfolio.

So far, the increasingly travel-focused retailer has proved to be a disappointment. Although its shares have narrowly outperformed the FTSE 250 index since being added to our portfolio in June 2021, they are nevertheless down by 13pc. 

The company has faced a tough operating environment, with factors such as Covid-related disruption to global passenger numbers, weak consumer confidence and an uncertain economic outlook weighing on its performance.

Encouragingly, the company’s half-year results, which were released last week, showed it is making good progress in what is a gradually improving operating environment. For example, revenue increased by 41pc as global passenger numbers continued to grow, average transaction value increased, and the company expanded into new product categories. 

This proved the catalyst for profitability, with pre-tax profits rising from £18m in what was a challenging first half of the previous year to reach £45m in the six months to February 2023.

Travel locations are becoming an increasingly important part of WH Smith’s business. They are expected to account for 85pc of profit in the current financial year, as the company continues to focus investment on what is a far more enticing growth opportunity vis-à-vis its legacy high street business. 

Indeed, travel sales are likely to overwhelm the company’s high street revenue, which has struggled to keep pace with evolving consumer trends, over the long run.

The company has a pipeline of 120 new stores at travel locations such as airports and railway stations. The majority of them will be outside the UK, which improves diversification and provides a clear long-term growth opportunity. 

With net interest payments on debt covered over three times by operating profit in the first half of the year, the company appears to have the financial strength to invest for future growth as it seeks to open more than 50 stores on average a year.

A recent bounce in British consumer confidence could act as a further catalyst on WH Smith’s financial performance. It recently rose to its highest level since February 2022 and, while high inflation is likely to continue to squeeze household budgets over the coming months and consumers remain relatively downbeat overall, an eventual slowing of the rate of price rises could boost the prospects for the wider retail sector. 

It may also reinvigorate investor sentiment towards what remains a relatively unloved industry.

With the world’s economic growth rate expected to increase from 2.8pc this year to 3pc next year, according to the International Monetary Fund, and demand for global travel likely to rise after the recent easing of Covid-related restrictions in countries such as China, the company’s operating environment is set to improve. 

Its lack of direct competition in travel locations in what essentially amounts to a captive market means that growing passenger numbers are likely to translate into higher sales and profits.

Trading on a forward price-to-earnings ratio of about 19, the company’s shares are by no means cheap. And their near-term performance could remain volatile as the full effects of global interest rate rises on economic growth becomes clear. However, the financial performance of WH Smith is likely to dramatically improve over the coming years after what has been a hugely challenging period.

A falling inflation rate, the end of interest rate rises and a return to pre-pandemic global passenger numbers are likely to catalyse the company’s share price performance. 

Alongside an ambitious investment programme that will further shift its focus to travel locations with superior growth potential, this means the stock remains a worthwhile holding in our Wealth Preserver portfolio.

Questor says: hold

Ticker: SMWH

Share price at close: £15.46

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