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Surging inflation is a godsend for these two companies

Image: B&M European Retail. Fair use

The weak pound has unsurprisingly been leading to strong inflation growth in recent months but even analysts were surprised when the ONS revealed inflation grew to 1.6% in December. Thankfully average wage growth is keeping pace for now, but for those Britons who haven’t seen a pay raise lately increased prices at stores will likely lead them to shop more often at discounters such as B&M (LSE: BME) and Sports Direct (LSE: SPD).

B&M may already be seeing the positive effects of surging inflation as it reported a bumper 20.5% year-on-year rise in overall revenue and 7.2% jump in UK like-for-like revenue for Q3. Sales were expected to exhibit solid growth as the company continues to expand into the South of the UK but such strong like-for-like growth in existing stores was a very welcome surprise.

Few are expecting B&M to maintain this high level of same-store growth indefinitely, especially if the domestic economy continues to grow at a steady clip. However, if inflation were to continue growing at an above-normal rate or the economy suffered a downturn, B&M would likely experience even higher levels of growth. That’s because the majority of the goods the chain sells are under £3 and management is constantly changing prices to best larger, non-discount rivals.

The company can afford to fiddle with prices in order to draw customers in because stellar EBITDA margins of 9% give it plenty of room to be competitive on prices but remain solidly profitable. B&M shares may look pricey at 20 times forward earnings but with the company planning to add around 50 stores per annum in the UK for the medium term, there’s reason to expect very good sales and earnings growth for the foreseeable future. Coupled with strong non-cyclical characteristics, a healthy balance sheet and growing dividends, B&M is one to watch, whether inflation soars or not.

And one to avoid?

Sports Direct could definitely use the assistance that penny-pinching customers represents as the weak pound, difficulties in Europe and a series of corporate governance scandals have caused share prices to fall over 30% in the last year alone. The bad news is, not only are these short-term problems slashing margins and profits, but that they come just as Sports Direct is seeking to rebrand itself as a more upmarket retailer or, in the words of management, to become the “Selfridges of sports retail“.

Moving the brand upmarket is problematic as it goes against the discount bargain warehouse vibe that has made Sports Direct so successful over the years. This could be a major problem if customers watching their wallets no longer immediately think of Sports Direct as the cheap place to buy trainers, hoodies and workout gear.

So far we’ve yet to see this problem as the company’s latest results for the half year through October 23 showed core UK sports retail sales increasing 5.6% year-on-year. However, higher staffing costs, the weak pound and inventory build-up sent group underlying pre-tax profits tumbling 57% to £71.6m compared to the year prior.

For the time being, Sports Direct will certainly welcome any shoppers who visit due to rising inflation. But an expensive rebranding, falling margins and profits, poor corporate governance standards and shares that still trade at 18 times forward earnings will keep me away far away from the company for now.

Slowing growth and external headwinds have battered Sports Direct but another clothing retailer that has faced no such problems is doing well enough that the Motley Fool's Head of Investing named it his Top Growth Share of 2016.

This founder-led business has grown sales every year since going public in 1997 and has rewarded shareholders with a 300% increase in share prices over just the past five years.

To discover why the Fool's analysts believe shares could triple again in the coming decade, simply follow this link for your free, no obligation copy of their report.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.