Consumer Staples Aren’t So Safe
The consumer staples sector has almost always been viewed as a “safe” investment. People thought of companies that make things like laundry detergent, canned food, shampoo, chips (or crisps for you UK readers), and pet food as relatively immune to economic trends. After all, people might not buy a new car or take a vacation if the economy tanks, but they still need to eat and brush their teeth. These days, however, things are changing for a lot of the companies that make consumer staples.
Traditionally, big consumer packaged goods companies targeted the growing middle class, using heavy advertising to convince everyone to spend a bit more on Tide laundry detergent or some other brand name product. But, the middle class has been fragmenting in many developed economies. The upper class and lower classes are growing. Instead of preferring major brand name products, consumers at the bottom rung gravitate toward generic, private label store brands while the customers at the top economic rung move to “luxury” oriented brands.
The advertising landscape is also changing. Previously, if you wanted to strengthen a consumer goods brand, then you had to put together a major television, radio, and/or print campaign (depending on the time period in history we’re talking about). It was complicated and expensive.
The digital world has changed some of that. Most digital advertising flows through one of two companies: Google or Facebook. The data they have on users allows start-up companies to target specific niches in a very cost effective way. Want to start a brand of giraffe-themed chapstick and market it to people who like giraffes? No problem. Facebook knows just whom you should target. As a result, it is much easier for competition to enter the market and chip away at sales and profits of the major consumer goods companies. It’s not death by a thousand paper cuts yet. We are, perhaps, at the injury-by-a-million-paper-cuts stage.
Another issue changing the consumer goods field is that retail sales continue to move online. As they do so, they flow from multiple retailers to one major player, Amazon (and to a lesser extent Wal-Mart and Target). This gives those large e-commerce companies unprecedented power to extract concessions from major packaged goods companies. For example, Amazon may charge Energizer more to display their brand more prominently when a consumer searches for “batteries.” Alternatively, Amazon could simply promote their private label brand at the expense of Energizer or force Energizer to lower its price to something closer to what Amazon charges for its own private label batteries.
Add to that the issue of how expensive many consumer staples stocks were, and still are. Many investors bought consumer staples stocks after the great recession because of their dividends. Interest rates were low and the 2%, 3%, or 4% dividends paid by many consumer goods stocks looked attractive. The businesses were viewed as “safe.” The problem now is that interest rates are rising, which means that bonds are becoming more attractive. The issues we highlighted above are hinting to investors that these businesses might not be as safe as they first thought. Many of these stocks were (and still are to some degree) trading at much higher prices than the stock market as a whole. Previously, it wasn’t uncommon to see a consumer staples stock trading at 20 or 25 times earnings compared to 16, 18, or 20 for the market as whole. Right now, the consumer staples sector is about the same or just slightly more expensive than the market on most valuation measures. The problem is that many companies in the sector are struggling to grow sales!
Let me point out that not every company in the consumer staples sector is equally affected by every issue I’ve raised. Some companies, such as Estee Lauder with its high-end cosmetics, are doing great. Companies heavily focused on emerging markets are much less affected. Other companies, such as CVS Health and Walgreens, are not affected by the factors I’ve discussed. Both companies are frequently included in the consumer staples sectors even though they are primarily health care companies. Generally speaking, however, a large portion of the consumer staples sector is dealing with various problems I’ve detailed.
Over the past few years, we’ve been steadily reducing our exposure to the consumer goods sector. Right now, our main portfolio has only two consumer goods holdings: small positions in Altria (MO) and Philip Morris International (PM). We believe there are better opportunities in other areas of the market. After all, would you rather pay less and own a company like Google that is easily growing at double digit rates or pay more to own a company like Coca-Cola that is struggling to grow at all. We’d rather build a portfolio of companies like Google, and we’ve done just that.
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Article by Ben Strubel, Strubel Investment Management