Investor Playbook: What Transurban, APA and Deterra have in common?
What inflation-resistant businesses have in common.
Just as a basketball coach relies on their playbook to navigate high-pressure moments, this column explores the frameworks, principles and behaviours that help investors make better decisions in their investment journey.
APA (ASX.APA), Transurban (ASX.TCL) and Deterra (DRR.ASX) operate in very different industries. Yet they share specific traits that have helped them protect earnings during periods of higher inflation. Understanding why can help investors identify similar opportunities across the market.
Here’s three common ASX holdings that are robust businesses with inflation resilient earnings.
Why inflation is a big deal for investors
Inflation is one of the greatest threats to long-term wealth creation. A $10,000 sum of cash stuffed under a mattress in 1970 would have lost around 93% of its purchasing power today. For context, the median Australian house price in 1970 was roughly $18,700.
To maintain the same purchasing power, that $10,000 would need to have grown to around $145,000 today. That equates to roughly $135,000 in investment gains, or a total return of about 1,350%, simply to break even before creating any real wealth.
When prices rise in inflationary environments, purchasing power falls. This why investors require higher nominal returns to compensate.
Consumers become more selective with spending and businesses face increasing pressure from rising wages, materials and financing costs.
Yet inflation does not impact every company equally.
Some businesses struggle because of their inability to pass on higher costs via higher prices. Others emerge relatively unscathed because they possess characteristics that allow revenues to rise alongside inflation, while costs remain comparatively stable.
Many investors already know that persistent inflation in Australia is a problem.
A productive counter to this problem is for investors to identify the types of businesses that are structurally positioned to cope and even thrive in these environments.
Inflation brings competitive advantages into play
In 1979, Michael Porter first published the well-known “Porter’s Five Forces” model which aimed to analyse the competitive forces within an industry.
Inflation provides one of the clearest real-world tests of a company’s competitive position. When costs rise across the broader economy, businesses are forced to answer two critical questions.
Can they pass those costs on to customers and can their suppliers pass costs on to them?
This is where two of Porter’s Five Forces become particularly relevant: customer bargaining power and supplier bargaining power.
Companies with low customer bargaining power and limited supplier bargaining power are often better positioned to protect earnings margins when inflation rises.
By contrast, businesses caught between powerful customers and powerful suppliers can quickly see profitability squeezed.
Viewed through this lens, inflation isn’t just a macroeconomic challenge. It’s a stress test of a company’s competitive advantage.
APA, Transurban and Deterra all possess characteristics that help them pass that test.
Trait 1: Pricing power and contractual protection
The best inflation-resistant businesses can either pass rising costs on to customers or have contractual arrangements that allow revenue to increase alongside inflation.
In Porter’s terminology, these businesses benefit from weak customer bargaining power. Customers have limited ability to push back against price increases because the service is essential, alternatives are limited or pricing is determined contractually.
Transurban is a clear example. Many of its toll road concessions allow tolls to increase annually by inflation or by a fixed rate (usually 4% or higher).
Transurban negotiates pricing contracts with State Governments before committing to funding of new toll roads.
APA is likened to a toll road operator for Australia’s energy needs. APA controls a 15,000km web of gas pipelines which connect half of all Aussies gas supply. APA benefits from long-term gas transportation contracts, many of which contain inflation-linked pricing provisions.
Primarily all of Deterra’s revenues are linked to the royalties generated by Mining Area C, run by BHP. The terms of the royalty state Deterra receive a percentage of the revenue earned from the iron ore mine. While these revenues do not contractually increase with inflation, higher commodity prices flow through to royalty income. This revenue model can also be likened to a toll road, only it is more leveraged to iron ore prices.
Different underlying return drivers, yet the revenues have a mechanism to keep pace with inflation.
Trait 2: Someone else bears the inflation risk
Inflation becomes far less damaging when another party absorbs the rising costs.
Deterra is perhaps the clearest example. The company receives royalty payments based on mine revenue rather than profit. If labour, fuel or equipment costs increase, BHP absorbs those expenses while Deterra continues collecting its royalty.
If BHP wanted to expand operations in the MAC area to increase iron ore production, it would require no additional capital from Deterra.
Our analyst Jon Mills believes that BHP plans to continue operations in the MAC C area over the next 50 years.
APA and Transurban are not as insulated as Deterra but both benefit from infrastructure assets that require relatively modest incremental spending to grow revenue. Once a pipeline or toll road is built, inflation-linked revenue growth does not require a proportional increase in operating costs.
The key is understanding where inflation ultimately lands. Many investors focus on which companies can increase prices.
An equally important question is which companies are able to avoid paying the higher costs in the first place.
Trait 3: Essential assets with few substitutes
The final common trait is that all three businesses control assets that are difficult to replicate or replace. This reduces competitive pressure and limits the ability of customers to seek alternatives when prices increase.
Drivers may not like paying higher tolls but alternative routes are often less convenient. Transurban’s portfolio of Australian roads are integral parts of the motorway networks in our three largest cities: Melbourne, Sydney and Brisbane.
The efficient scale of this network underpins Transurban’s wide economic moat.
Energy retailers, LNG exporters and industrial companies still need access to APA’s pipeline network to transport gas around the country.
APA is by far the largest gas pipeline companies servicing the domestic gas market. The scaled efficiency of its network too underpins its narrow economic moat.
Mining Area C is a world-class, long-life iron ore asset in the Pilbara and BHP has already invested billions of dollars into the mine, rail and port infrastructure that supports it. The economic incentive is to continue maximising the value of this long-life resource, which supports royalty payments to Deterra as production and iron ore revenues grow.
Businesses with essential assets, high switching costs or limited competition often possess a natural defence against inflation because customers have few viable alternatives.
The hidden risks
Investors should avoid assuming that any business benefiting from inflation is automatically attractive.
APA and Transurban both carry significant debt loads. While inflation-linked revenues can be beneficial, higher interest rates frequently accompany periods of elevated inflation. Businesses with excessive leverage may find some of the benefits offset by rising financing costs.
Similarly, Deterra’s royalty model is highly dependent on iron ore production and commodity prices. Inflation may support commodity prices assuming it flows through to a steepening cost curve and higher commodity prices.
However, a sharp slowdown in iron ore demand can negatively impact earnings.
Finding companies to benefit through the cycle
When evaluating a company, look beyond industry labels and ask three questions:
1. Does the company have pricing power?
2. Can revenue grow alongside inflation?
3. Can the company maintain or expand margins as costs rise?
APA, Transurban and Deterra arrive at favourable answers through very different business models.
What they have in common is a durable competitive advantage that helps protect earnings through different stages of the economic cycle, not just during periods of elevated inflation.
For investors, that is often where the most valuable insights lie: understanding the underlying business drivers that ultimately determine long-term returns.
