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Analisi 30.10.2017

Consumer Staples - The end of an era?

Consumer Staples - The end of an era?

Market and corporate lifecycles can last a very long time and create large valuation anomalies offering great opportunities for active managers.

  • Our thesis is that the very long upcycle for Consumer Staples is showing clear signs of ending.
  • Sales are slowing as consumer preferences change and high returns are attracting new entrants taking advantage of falling barriers to entry and new, disruptive, routes to market.
  • This is occurring at a time when conditions in fixed income markets have pushed valuations to extreme levels in the sector based on the assumption that future returns will be reliable and ‘bond-like’, we strongly dispute this received wisdom.
  • Our portfolios are significantly underweight and we find more attractive growth elsewhere.

Why are sales slowing?

Life has become a lot tougher for the listed consumer staples companies. Sales growth targets have become more of a struggle and the traditional levers (brand power and marketing spend) are no longer working.

The Fast Moving Consumer Goods (FMCGs) have, since the golden-era of advertising in the 1950s, been the gateway to the consumer. As investors, historically, there has been no more direct and reliable way to access defensive, predictable, consumer spending. This is no longer the case. Technology (social media) has lowered barriers to entry and a new generation of consumers are mistrustful of ‘big business’.

The Consumer Staples sector has faced and defeated challenges before (private label, volatility of emerging markets, supply chain problems etc). However, these new problems present a unique challenge – one that neither price nor advertising spend can solve.

The unique selling proposition of the sector was brand power and this has been achieved through billions of dollars of marketing spend – big brands are safe, trustworthy, higher quality and comforting. This allows them to charge a significant premium to own-label. The problem is that to Generation Y, these brands fall into the same category as the mainstream print media, and political parties…. big, with hidden agendas and run for the benefit of a few at the top. To add to this, new, niche brands are gaining huge traction as start-up costs fall and marketing can be channelled through Instagram or Twitter. These small brands often command similar, if not higher price points. Most importantly of all, they are seen as authentic and trustworthy.

At best, this is a big shift to which the Consumer Staples will have to adapt, at worst an existential threat. But these businesses are resourceful and used to protecting market share, so although the game has changed they are fighting back. The biggest weapon so far has been M&A – in the form of big, cost-base driven mergers and also buying up the brands that are threatening them (Rachel’s yoghurt – Nestle,        Teapigs – Tata, Dorset Cereal – AB Foods). This strategy is not without its flaws. The opportunity for big mergers is obviously limited (and so are the benefits). Buying small brands is also a potentially dangerous strategy. The valuations of these businesses are high, the way they are run is very different and they may be growing fast, but are typically small and therefore of limited impact to group profit.

Most importantly, can the essence of an artisan brand still appeal if it is owned by, say, Unilever? Just how deep is the Gen Y search for authenticity? If it is just appearance that counts…the big FMCGs have a chance if they leave their new acquisitions to run themselves and give the impression of being stand-alone (e.g. Heineken and Lagunitas), whilst at the same time providing the back office and distribution network of a global business.

A look back at stock-market history

The current consensual view of Consumer Staples (low volatility, high return companies that behave like bonds) has not always prevailed.

Just like most other industries there have been cycles; we just have to look far enough back in time to spot them, but this is perhaps too far for most market participants to remember.

It is well worth a look at some episodes in the lifecycle of the sector that may resonate with some of today’s issues, simply put they are stories of market share loss and how the industry and stock-market responded to those threats.

‘Path to growth’ or Road to Nowhere?

While investors watched the tech bubble come and go at the beginning of the decade, the Consumer goods industry was facing some slower moving but disruptive trends of its own.

Global markets for Food, Beverages and Personal goods were growing at a solid 3-4% but the Branded Goods companies struggled to capture the growth.

The key problem was a shift in the balance of power towards the Supermarkets. Most major geographies had seen widespread retail consolidation and the Supermarkets had a competitive stick to beat suppliers with – ‘Own Label’ product.

Own label products can be priced at a discount as they do not need a high margin to support brand advertising. Consumers were happy to make the switch, particularly in more challenging times, The big retailers made it a strategic imperative to shrink shelf space for the big brands.

As a result there was pressure on volume and prices, much as we expect for the coming years, albeit from a different source of competition. FMCG’s responded with cost cutting and the sale of weaker brands, focusing on fewer ‘Power Brands’ that were seen as essential for consumers. This strategy was typified by Unilever’s ‘Path to Growth’ (c.2000) which was effective in cutting cost and reducing brands but failed to relieve the pressure on sales.

During this period the sector suffered from erratic trading trends and valuations were depressed with stocks regularly trading on discounts to the market.

In early 2003 Unilever traded on a modest 12x Earnings, apparently cheap but not cheap enough to avoid 4 years of consistent underperformance thereafter.

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