Is there a demand for consumer stocks?

(Image credit: Yuichiro Chino)

Branded consumer staples are usually seen as a very defensive sector. They tend to beat the market when investors get nervous about growth. That pattern isn’t playing out as reliably as it normally does in this cycle.

While a few staples firms are performing very well – Colgate Palmolive is up 25% this year – many other stalwarts, from Nestlé to Mondelez, are not. In some cases, the weakness is down to a specific problem (Reckitt’s decision to buy Mead Johnson in 2017 stands out).

In other words, it’s clear that firms are struggling to balance pricing power against volumes. Many have put up prices to pass on higher costs and protect margins. This kept both revenues and profits growing, but caused the volume of goods sold to shrink. You can’t keep doing that forever, because higher prices and shrinking sizes may cause shoppers to trade down to cheaper brands permanently.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

However, there is another trend in play. We’ve also seen notable weakness in both results and share prices for spirits firms, breweries (Heineken), beauty (L’Oréal), luxury goods (LVMH) and more. What links many of these together is not just uncertainty about consumer demand right now, but how much long-term value we should put on the power of a brand.

Are consumer stocks still popular?

Top consumer brands produce higher and more reliable earnings, and so investors have been willing to pay higher valuations for these stocks. A compelling growth story – typically in emerging markets, where consumers buy more branded goods from snacks to toothpaste to cosmetics to luxuries as they become wealthier – also helped justify premium multiples.

Now it looks as if investors are getting a bit more wary about this. After expanding for many years – since the global financial crisis in some cases – multiples are now contracting. At the end of 2019, Diageo traded on about 23 times forecast earnings. Now it trades on under 15. The shrinking multiple has made a much bigger difference to the share price than the change in earnings.

This isn’t happening in all stocks, and it is far more pronounced in Europe than the US, but there is a trend towards less bullish valuations. The question is whether that reflects investors getting unduly rattled over short-term earnings or rethinking some structural issues. Perhaps margins may have to come down for years, not quarters, to defend market share.

Maybe social shifts will cause younger generations to drink fewer spirits. New anti-obesity drugs could curb demand for snack food, alcohol and other impulses. Weaker long-term growth in emerging markets would mean fewer new consumers. On the financial side of the equation, higher interest rates reduce the attraction of the steady dividends that many of these stocks pay.

Reratings do not just go one way. Unilever, which was firmly out of favour, is being rewarded with a higher multiple as markets come to trust in a turnaround. However, it seems likely that consumer stocks in general will get less of a valuation tailwind for a while.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Cris Sholt Heaton is the contributing editor for MoneyWeek.

He is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is experienced in covering international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers.

He often writes about Asian equities, international income and global asset allocation.