Branded consumer staples companies have long been loved by investors but their reliability can no longer be taken for granted as market structures and buying habits evolve.
A favoured theme
Branded consumer goods, especially consumer staples, have been a favoured investment theme for many investors. Often these are profitable, predictable businesses, with compelling dividend yields, and some top line growth, especially for those companies with a meaningful exposure to emerging markets.
In particular, the dividend yield offered by these companies has appealed to investors. Lower yields elsewhere has resulted in these companies being seen as ‘bond proxies’, offering relatively safe, reliable returns and higher yields than the bond market. This has created a perception of capital protection. However, a number of challenges mean this perception might be starting to fade.
Big branded consumer goods companies owe their strong market position to historical advantages over the competition – but many of these benefits are starting to erode.
In the past, these companies had the scale and financial muscle to advertise on national media and build brand recognition in a way smaller companies could not. Now, digital media and social media platforms allow consumer goods companies to generate brand awareness by targeting specific niche audiences on a smaller marketing budget.
Formerly, these companies had a strong manufacturing advantage. Now contract manufacturers can produce goods that rival the quality of the big brands - from clothing to detergents to cosmetics − boosting discounters with strong private label brands (see Chart 1).
Once, these companies had strong relationships with retailers, allowing them to dominate shelf space. Nowadays, new entrants can ship direct to the consumer, using platforms like Amazon or T-Mall. Also, retailers themselves are busy launching their own ‘private label’ products at lower prices but comparable quality.
In the US shavers market, where Gillette has dominated for years, new entrants like Harry’s Razors and Dollar Shave Club have gained 20% market share in four years – a feat which no challenger brand has achieved before.
This prompted Unilever, an incumbent big brand company, to acquire Dollar Shave Club for one billion dollars.
In Europe, private label food products now exceed 40% of sales in large markets such as Germany, the UK and Spain, and continue to grow rapidly at the expense of traditional established food brands (see Chart). In popular discounter supermarkets such as Aldi and Lidl, that percentage is even higher. The US has been late to adopt this trend – nationwide, only about 17% of sales are private label but leading retailers such as Costco are pushing this number higher.
Big brands forced to adapt
This change is now affecting the economics of big brand companies, with firms like Nestle, Reckitt Benckiser and others accepting that their growth is more challenged. To protect profitability, some are now cutting costs like advertising and promotion expenditure – a strategy sometimes referred to as ‘zero base budgeting’. This move led to a series of disappointing results from ad agencies and TV broadcasters, the very channels that once helped build those mega brands.
This approach may be counter-productive. Stopping advertising activity can provide short-term cost savings, but may lead to a decline in the brand in the long term.
The lessons for stock-pickers
What does this mean for the global stock-picker? For one thing, the reliability of the big brands’ revenue lines can no longer be taken as a given. Moreover, valuation multiples are still high, suggesting that investors do not fully appreciate this risk.
However, there are also opportunities. Some consumer staples companies were early to adjust. Kraft Heinz – a product of the merger between Kraft and Heinz, with backing from 3G Capital and Warren Buffet - was one of the first to introduce zero-based budgeting for lower-growth products.
Growth also continues in categories like functional and performance nutrition, thanks to well-being and health trends. Mead Johnson, a leading manufacturer of infant nutrition, was acquired by Reckitt Benckiser for $18 billion in June this year. Further down the market capitalisation spectrum, Glanbia, an Irish listed manufacturer of protein sports nutrition products, continues to grow and build a leading – if niche – brand.
As always, understanding the implications of a material industry change, and finding individual companies that benefit from that change is key to successful stock picking.