BP, Tesco, and British American Tobacco are 3 of the best FTSE 100 defensive stocks as all three sell products which benefit from inelastic demand.
As the Bank of England forewarns investors that the UK economy will contract in Q4, and continue to shrink through the entirety of 2023, thoughts of how to invest through the recession are starting to dominate the trading discourse.
When GDP shrinks, it becomes much harder to pick stock market winners. But with CPI inflation set to strike 13% by year-end, investors are left with little choice but to try to protect their cash from inflation erosion while minimising the risks as much as possible.
Fortunately, the FTSE 100 is jam-packed with defensive stocks that often outperform the wider market during recessions.
Inelasticity of demand
Some of these best FTSE 100 defensive stocks are considered safe havens by investors as they benefit from inelasticity of demand.
This means that regardless of the extent to which external economic conditions deteriorate, their earnings, dividends, and share prices remain stable because they sell a service or product for which there is constant demand.
This might be because they hold an overwhelmingly dominant market position, have an excellent reputation, or provide a basic necessity.
As an extreme example of inelastic demand, consider insulin. As American pharmaceutical giants have discovered, diabetics will pay beyond inflated prices, as without the drug, they will die. And if the supply of insulin were to drop by 20%, the price would shoot up by considerably more.
This is exactly what is playing out in the oil and gas markets. Soaring post-pandemic demand combined with reduced Russian supply is seeing the cost of energy skyrocket. This is because the energy needs remain constant, and wealthier countries will pay more for access to the reduced supply.
3 best FTSE 100 recession stocks
1) BP (LON: BP)
At 429p today, BP shares are up 42% over the past year on oil and gas multi-year highs. Despite falling from $140 earlier this year to under $100 today, Brent Crude is still substantially above the $70 2021 average. And with no end in sight for Russia’s invasion of Ukraine, oil and gas prices are likely to remain elevated for some time to come.
Accordingly, despite the current and potential future windfall tax, Q2 saw the FTSE 100 oil major post its highest quarterly profit since 2008, with underlying cost replacement profits up 200% year-over-year to $8.45 billion.
BP has increased its dividend by 10% and is planning $3.5 billion of share buybacks in this current quarter. And with oil and gas demand so inelastic, but dependent on significantly reduced supply, further record profits seem likely.
2) Tesco (LON: TSCO)
Up 9% over the past year to 268p, Tesco also benefits strongly from inelasticity of demand, perhaps even more than BP. Every consumer must eat and drink, regardless of inflation or recession. This means Tesco can pass on inflation easier than in other sectors, despite strong competition in the grocery sector.
In fact, the market leader saw its market share increase by 0.2% in Q1 to 26.9%, while group sales rose by 2% year-over-year to £13.57 billion.
Tesco will spend £750 million on share buybacks by April 2023, shoring up its share price in the face of the downturn. And with adjusted profits of £2.8 billion in 2021, its dividend per share rose by 19.1% to 10.9p for the year.
Moreover, it’s seeing 19% growth in its Aldi Price Match and Low Everyday product ranges compared to this time last year. Despite the lower margins, this could see Tesco grow market share further, especially as recently bought-out Morrisons is likely to shift its focus to profitability.
Of course, this could come at the expense of higher margin items. And there is the risk that cash-strapped consumers will soon be forced to cut discretionary spending, with grocery bill luxuries first on the chopping block.
3) British American Tobacco (LON: BATS)
BATS is up 36% over the past year to 3,408p after a few years of share price falls. Tobacco, while morally questionable, is an effective inflationary hedge as it is another prime example of inelastic demand — nicotine is addictive and consumers will sacrifice elsewhere to maintain their habit.
In half-year results, CEO Jack Bowles told investors that the FTSE 100 company remains ‘well positioned to navigate the current turbulent environment due to our powerful brands, operational agility and continued strong cash generation.’
The numbers back him up. Revenue rose by 3.7% to £12.8 billion, of which ‘new categories’ revenue increased by 45% to £1.2 billion, driven by non-combustible product consumers increasing to 20.4 million. Further, the FTSE 100 tobacco company converts profits to cash at a generous 90% rate, helping to deliver its ongoing £2 billion share buyback scheme.
It does have risks of course; tobacco use is slowly falling globally, and BATS will eventually rely on non-combustibles such as vaping to plug the revenue gap. And in key market the US, there are strong political efforts to reduce vaping use.
But with recession imminent, BP, Tesco, and BATS could be excellent FTSE 100 defensive stock picks.