Editors' pick: Originally published Feb. 25.
Which companies have the best opportunities to raise prices on their products or services without lessening consumer demand for them? According to a Morgan Stanley report out this week, these 18 companies have the strongest pricing power.
"While assessing a company's pricing power has long been a cornerstone of bottom-up investment research, it is arguably even more critical in the current environment," the Feb. 23 report read.
U.S. consumer price inflation may be inching higher, with the Consumer Price Index rising 0.3% in January, excluding food and energy, according to the Labor Department. However, Morgan Stanley's Feb. 23 report noted that "core goods prices are largely determined by external developments," such as the U.S. dollar, global growth and commodity prices. Hence, January's uptick in inflation is not likely to be sustained, it read.
Morgan Stanley analysts were asked to name stocks among their coverage lists that are expected to "exercise pricing power in the near- to medium-term as well as exhibit key indicators that would serve as evidence of that pricing power." The selections were limited to stocks with buy- or hold-equivalent recommendations as well as those for which the ability to raise prices was a "needle-mover" for company profit, the note said.
"Our list includes healthcare companies that focus on innovation, ones that have recurring revenue models with a value proposition that emphasizes location, ones that possess strong brands in growing categories, and some that offer consumables with low demand elasticity," the report said.
Below are the 18 stocks with the strongest pricing power, according to Morgan Stanley. We've paired the list with commentary from Jim Cramer, if the stock is owned by his Action Alerts PLUS charitable trust portfolio.
Industry: Telecom Services
Morgan Stanley has a $125 price target on American Tower (AMT) .
"Towers effectively offer local monopolies, and there is little alternative for carriers wishing to add capacity to improve network quality. Contracts typically include 3%+ annual escalators, and the companies generally show high-single-digit same-tower growth," analyst Simon Flannery said.
Morgan Stanley has a price target of $193 on Amgen (AMGN) .
"While drug pricing has been a topic of debate since U.S. presidential candidates raised focus on the topic in the late summer of 2015, we continue to see pricing power among large cap biotech," analyst Matthew Harrison wrote.
"Amgen sells a wide variety of supportive products for cancer treatment, inflammatory, bone and renal diseases. In 2015, management took high-single-digit to mid-double-digit gross price increases across its portfolio (we estimate high-single- digit net price) and we would expect mid-to-high-single-digit net pricing power to continue in 2016," he wrote.
Morgan Stanley has a price target of $419 on Biotech (BIIB) .
"Biogen sells a variety of products for the treatment of Multiple Sclerosis including Tysabri, Tecfidera, and Avonex," analyst Matthew Harrison wrote. "In 2015, management took [approximately] 11-12% gross price increases across its portfolio (we estimate mid-single-digit net price) and we would expect a similar net price trend in 2016."
"Beyond the political rhetoric and potential for regulatory scrutiny (to which Biogen is more exposed given its history of more aggressive price increases), the company is facing an intensely competitive backdrop within the multiple sclerosis (MS) drug market. The competition further pressures pricing, and while Biogen does possess a variety of novel therapies that have 'blockbuster' potential, the most exciting potential therapies are in the earliest stages of development and, as a result, are difficult to value without incremental data points," they added. "The high risks come with potentially high rewards, which is why we rationalized, rather than eliminate, our exposure (the position still represents 3.4% of our portfolio, vs. 4.2% prior to the trim). We maintain our $350 price target (lowered from $375), but prefer safer biotech investments such as Allergan (AGN) and Eli Lilly (LLY) ."
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Industry: Major Pharmaceuticals
Morgan Stanley has a price target of $74 on Bristol-Myers Squibb (BMY) .
"We believe BMY will exhibit pricing power over the next 24 months," analyst David Risinger wrote. "We see good visibility for low-mid-single- digit price inflation, driven by high-value medicines. The company is rolling out Opdivo, a compelling new cancer treatment, which will likely drive a mix shift toward higher-priced and higher-margin revenue over the next few years."
Morgan Stanley has a price target of $115 on Celgene (CELG) .
"Celgene sells a variety of hematology products, mainly for the treatment of multiple myeloma. In 2015, management took 7-10% gross price increases across its portfolio (we estimate mid-single-digit net price) and we would expect a similar net price trend in 2016," analyst Matthew Harrison wrote.
Morgan Stanley has a price target of $68 on Comcast (CMCSA) .
"In cable, we believe Comcast can grow residential [average revenue per user] by [approximately] 3% per year over the near to medium term, underpinned by its recent investments in broadband/WiFi and its next gen video platform (X1)," analyst Benjamin Swinburne wrote.
Morgan Stanley has a price target of $173 on Constellation Brands (STZ) .
"We believe STZ will exhibit strong pricing power over the next 12 months, but also longer-term in its beer business (two-thirds of total profit) for a few key reasons," analyst Dara Mohsenian wrote.
The company "has ample room to increase pricing given market-share momentum across the portfolio supported by greater brand reinvestment and demographic tailwinds," Mohsenian wrote.
As well, the beer industry is "relatively demand-inelastic to pricing."
Key beer industry players "both have higher debt leverage post recent deals, which should drive a rational pricing environment" and finally, "the halo from higher-priced craft beers ([approximately] 50% premium to domestic light beer) gaining share in the beer industry makes STZ's Mexican import portfolio look more affordable," the analyst wrote.
Morgan Stanley has a price target of $268 on Equinix (EQIX) .
"Equinix operates data centers in premium locations in most global financial hubs; customers need to locate in Equinix facilities to access ecosystems of other financial services, network, and cloud providers," analyst Simon Flannery wrote. "Evidence of this pricing power can be seen in rapid growth in interconnections, which demonstrates the need to be connected in that data center."
Morgan Stanley has a price target of $90 on Extra Space Storage (EXR) .
"Pricing growth (rent growth) for EXR (a self-storage REIT) has trended from 4% in 2014 to 5% in 2015, and for 2016 we expect 6%," analyst Vikram Malhotra wrote. "Factors allowing ongoing pricing power include: record occupancy that has historically been a precursor to pricing power; a technology platform that enables EXR to segment customers; low supply."
Industry: Specialty Retail
Morgan Stanley has a price target of $107 on L Brands (LB) .
L Brands' two main brands -- Victoria's Secret and Bath & Body Works - have each shown 1% to 2% price growth over the past five years.
"Some examples of our store check data showing pricing power are: at VS there's been an average annual price increases of 2% for lace panties (3/$30 in 2010 to 3/$33 today); 2% for cotton panties (5/$25 2010 to 5/$27.50 today; 8% for PINK cotton bra (2/$32 in 2010 to 2/$45 today)," analyst Kimberly Greenberger wrote. At Bath & Body Works, "we have seen a 4% average annual price increase for hand sanitizers (5/$5 in 2010 to 5/$6 today); 5% for hand soaps (4/$15 or 6/$20 to 4/$20 or 6/$24 today); and 4% for 3-wick candles (2/$20 in 2010 to 2/$24 today)."
Industry: Health Care/Life Science Tools & Diagnostics
Morgan Stanley has a price target of $333 on Mettler-Toledo International (MTD) .
"We think management expectations calling for 150 basis point a year in price increases are conservatively biased, given the company's track record of generating annual increases well in excess of this target," analyst Steve Beuchaw wrote.
"Since 2009 Mettler has generated an average price increase of [approximately] 200 basis points a year. Our survey data, which suggests Mettler will continue to gain share despite its price increases, gives us confidence that pricing power continues," Beuchaw continued. "The ability to drive such consistent increases stems from Mettler's favorable position in its customers' supply chain, the fragmented nature of its competitors and customer base, and its sophisticated targeted marketing approach. We believe Mettler's pricing power is a key lever in driving gross margin expansion."
Morgan Stanley has a price target of $17 on Mindbody (MB) .
"We believe MB will benefit from pricing power in 2016 on the back of pricing increases recently implemented by the company," analyst Brian Essex wrote. "Although the company is still working toward profitability, its initial market strategy was to penetrate its market with software that solved for significant pain points in business processes at prices that were extremely compelling for its target wellness markets."
"The company's recent price increases were for several pricing tiers across its platform, including its new top pricing tier for its software customers," Essex continued. "Our conversations with customers indicate a high rate of return relative to what they pay to be on MB's platform and we expect the higher prices to stick, particularly with the introduction of additional functionality."
Morgan Stanley has a price target of $95 on Philip Morris International (PM) .
"For PM, we see ample pricing opportunity over the coming years, as its pricing momentum has meaningfully accelerated in 2015," analyst Matthew Grainger wrote. "PM's recent commentary during its 4Q15 conference call indicated that the company experienced 'strong pricing across all regions' and was a key aspect of its favorable 2016 outlook. Beyond continued pricing momentum across Latin America and Eastern Europe, we expect PM to benefit from improved pricing flexibility (and profit growth) in the EU, as well as the continued restoration of more normalized price points in the Philippines."
Morgan Stanley has a price target of $48 on Reynolds American (RAI) .
"We believe RAI will exhibit pricing power over the next 12 months and have room for continued pricing growth beyond this year," analyst Matthew Grainger wrote. "Our recent cigarette affordability deep dive suggests a substantial pricing opportunity in the US. US tobacco industry pricing has been meaningfully stronger than expected during the past 12-18 months, increasing 5-7%. In 2016, we expect RAI to continue to realize solid 4-5% underlying pricing (enhanced further by positive mix associated with Newport)."
Industry: Hardline/Broadline Retail
Morgan Stanley has a price target of $30 on Sally Beauty (SBH) .
"The company is currently exhibiting pricing power in two ways. First, on the cost of goods sold side, SBH is seeking better terms from its suppliers. Given that SBH sells a significant portion of private label (50% of products), SBH is seeing success. This started to show in the December-quarter (F1Q) results and should continue throughout the year," analyst Simeon Gutman wrote.
"Second, SBH is raising prices to consumers. Thus far, this has been highly successful and according to the CEO, they are just 5-10% underway," Gutman continued. "What helps SBH with pricing power is very low average ticket and basket sizes. Typically, baskets are $20-30 with 3-4 items. With the average item [approximately] $6, SBH can raise prices by nominal amounts without the customer experiencing a material effect. Plus, with 50% of items private label, it's hard to compare pricing across the market."
Industry: Telecom Services
Morgan Stanley has a price target of $138 on SBA Communications (SBAC) .
"Towers effectively offer local monopolies, and there is little alternative for carriers wishing to add capacity to improve network quality. Contracts typically include 3%+ annual escalators, and the companies generally show high-single-digit same-tower growth," analyst Simon Flannery wrote.
Morgan Stanley has a price target of $305 on Sherwin-Williams (SHW) .
"We expect Sherwin-Williams to exhibit pricing power as we continue to move through a period of sustained raw material deflation," analyst Vincent Andrews wrote. "Sherwin retained price in 2015 so as to drive +280bps of incremental gross margin gains, and we expect the company to benefit further in 2016 as the coatings raw material environment remains similarly accommodating."
"Sherwin's pricing power relates to its control of its own distribution, as well as its outsized leverage to professional painting contractors. The contractor-serviced architectural paint market has historically been characterized by robust levels of pricing power," Andrews continued.
Morgan Stanley has a price target of $64 on Starbucks (SBUX) .
Starbucks "remains the category leader in the high-margin, premium coffee segment and benefits from selling an often-craved, habitual product," analyst John Glass wrote. "SBUX does not specifically break out its pricing, but it has commented in the past that it generally takes 1-1.5% pricing every year, which is more effective and less visible to consumers than larger, 3-4% price increases more infrequently."
Cramer's Action Alerts PLUS portfolio owns shares of Starbucks. "This is a company that is firing on all cylinders that people are concerned about because it has big Chinese sales and because it didn't blow away the numbers last time," Cramer recently said. "I say that Howard Schultz is doing an amazing job and his company's doing better than ever and the weakness is a buying opportunity."
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