Morgan Stanley says rising wages will cut into corporate profit margins by more than 700 basis points — use these 3 simple stocks to play defense

Morgan Stanley says rising wages will cut into corporate profit margins by more than 700 basis points — use these 3 simple stocks to play defense
Morgan Stanley says rising wages will cut into corporate profit margins by more than 700 basis points — use these 3 simple stocks to play defense

Corporate earnings are one of the main drivers of the stock market. But right now, there’s one thing that could become a major drag for corporate profits: rising wages.

According to a recent report from Morgan Stanley, wages are eating into corporate earnings, a trend that has only accelerated post-pandemic.

“The record-breaking pace of the economic recovery has come with very fast wage growth,” the Wall Street giant writes. “If we are right, monetary and fiscal policy will henceforth create persistently tight labor markets, meaning that the case for a structural uptrend in wages — and therefore the labor share of income — is strong.”

That doesn’t bode well for corporate bottom lines.

“In our top-down economic model, the full convergence of real wages with productivity implies that the economy-wide pretax profit margin declines to 10.7% from 17.8% today.”

That said, Morgan Stanley also identifies several companies with material upside and far less exposure to higher labor costs.

Here’s a look at three of them.

Nike (NKE)

Sports apparel and footwear giant Nike has been a popular stock for investors. Over the past five years, shares have climbed more than 130%.

Management is also returning cash to investors. In the most recent quarter, Nike paid out $484 million in dividends to shareholders — up 12% from the prior-year period.

Those dividends are backed by a profitable business. For the quarter, Nike earned a profit of $1.4 billion. Meanwhile, its revenue grew 5% year over year to $10.9 billion.

Morgan analyst Kimberly Greenberger is confident in Nike’s ability to deliver strong earnings despite rising wages in the U.S.

“We expect Global Brands to be relatively insulated from wage inflation given lower store counts and high revenue penetration in the wholesale & eComm channels,” she writes. “Additionally, revenue exposure to international geographies could help alleviate pressures from US wage inflation.”

Greenberger has a price target of $192 on Nike — about 57% above where the stock sits today.

Knight-Swift Transportation Holdings (KNX)

Knight-Swift is in the freight transportation business, providing multiple truckload transportation and logistics services throughout North America.

Having Knight-Swift on this list may seem counterintuitive because pay raises have been common in the transportation industry amid the driver shortage. But Morgan analyst Ravi Shanker sees the company coming out just fine.

“While TL driver wages have seen some of the sharpest increases over the last two years, KNX's relatively low exposure to wage-driven costs as a % of revenues and remarkable pricing power (evidenced by EBIT growth 2x the group average) should position them well to navigate wage inflation,” he says.

“We believe scale and exposure can make them the biggest beneficiary of any additional upside from the cycle.”

Knight-Swift is already delivering rapid growth in this cycle. In Q1, consolidated revenue rose 45.4% year over year while consolidated operating income shot up 83.7%.

The company hasn’t been an investor favorite lately as shares are down about 19% year to date. But Shanker sees a rebound on the horizon. His price target of $85 implies a potential upside of 74%.

Rockwell Automation (ROK)

More and more companies are choosing to automate their processes in the face of rising labor costs. And that means a significant tailwind for Rockwell Automation — a global leader in industrial automation and digital transformation.

“We view Rockwell as a prime beneficiary of secular investments driven by a multitude of catalysts converging (supply chain constraints, labor shortages, near-shoring) as technology is improving and paybacks are shortening,” writes analyst Josh Pokrzywinski.

He adds that because Rockwell can also increase automation in its own factories, the stock is “fairly insulated from higher wages.”

Rockwell shares are down 36% in 2022. But the company recently reported that in the March quarter, total orders were up 37% year over year.

Rockwell’s improvement should give contrarian investors something to think about. Pokrzywinski has a price target of $277 on Rockwell shares — 27% higher than the current levels.

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