3 things to keep in mind before investing in the consumer goods sector

Before you invest in companies of the consumer goods sector, you should read the following article. The 3 key take ways from this article are:

  1. In the past, the consumer goods sector was a save harbor in periods of high market volatility or economic downturn. But there are signs that the future does not match the past.
  2. Emerging markets offer great potential for the future success of companies in the consumer goods sector.
  3. Investments in digitization, especially in e-commerce, are essential to identify customer needs and to secure revenue growth.
Now, let’s see what is the most important information about the consumer goods industry before investing into this sector….

Basic understanding of the consumer goods sector

The consumer goods sector can be divided into two parts (Source: Vanguard)

  1. Consumer Discretionary: Companies that manufacture products and provide services that consumers purchase on a discretionary basis.
    Examples are:
    • Apparel, textiles (Nike, Inc.)
    • Food service/lodging (McDonald’s Corp., Marriott International, Inc.)
    • Household furniture, appliances (Williams-Sonoma, Inc., Whirlpool Corp.)
    • Leisure-related (The Walt Disney Co., Brunswick Corp.)
    • Printing and publishing (The McGraw-Hill Companies, Inc.)
    • General retail (Target Corp.)
  2. Consumer Staples: Companies that provide direct-to-consumer products for daily live that, based on consumer purchasing habits, are typically considered non-discretionary. Examples are:
    • Food products (Campbell Soup Co., Archer Daniels Midland Co.)
    • Beverages (The Coca-Cola Co., Anheuser-Busch Companies, Inc.)
    • Soaps and toiletries (The Procter & Gamble Co., Colgate-Palmolive Co.)
    • Tobacco (Altria Group, Inc., Reynolds American Inc.)

The consumer goods sector is dependent on the economic outlook, because if the economy is doing well and consumers have more money available, they are more willing to spend it. One indicator if consumers have more money to spend is the consumer confident index. A second indicator is the unemployment rate. The following charts shows the consumer confident index of the counties in the OECD. The graphics are interactive, so that individual countries can be included and excluded. Just click on the countries’ name in the legend to be able to better read the graph.

The following charts shows the unemployment rate of the counties in the OECD. The graphics are interactive, so that individual countries can be included and excluded. Again, just click on the country names in the legend to (de-)select them.

Let’s evaluate company performance across the entire sector. Therefore, take a look at the development of the S&P 500 Consumer Discretionary [Sector] ($SRCD), the S&P 500 Consumer Staples [Sector] ($SRCS), and the S&P 500 over 5 years, 3 years and 1 year.

  • S&P 500 Consumer Discretionary [Sector] ($SRCD)
  • S&P 500 Consumer Staples [Sector] ($SRCS)
  • S&P 500
5 years consumer goods vs SP500
3 years consumer goods vs SP500
1 year consumer goods vs SP500

The following table sum up the performance of the 3 indexes in comparison.

SP 500 Consumer Discretionary ($SRCD)S&P 500 Consumer Staples ($SRCS)SP 500
5 years+70.6%+30.6%+53.8%
3 years+45.2%+6.0%+40.1%
1 year+7.4%+4.5%+4.4%

There are a number of reasons behind the relative poor performance of consumer staples companies over the last 5 years in comparison to the whole market (Source). These factors might be key to understand and keep in mind when choosing a good consumer goods company to invest in.

Between 2006 and 2011 consumer goods companies grew on average 7.7% per year. In contrast between 2012 and 2016 the annual growth slowed down to 0.7%. There are a number of factors for this decline in growth:

Consumer staples impact on growth

Lower growth in previously booming developing markets like Russia, India, Mexico, Brazil, China. Economic slowdown goes in line with strong devaluation of the countries’ local currencies. Thus, consumers have to pay higher prices to buy products and services from this sector.

M&A activities with no meaningful growth. Since 2009 net debt in the consumer staples industry has tripled. The rest of the consumer goods market could de-lever, i.e. reduce its net debt, from 5.3 to 3.3. The leverage was used for several purposes:

  • Return money to shareholders via dividends. For example Coca-Cola reported declining earnings per share (2013: $2.12 to 2017: $1.93) but increased dividends per share (2013: $1.12 to 2017 $ 1.48)
  • Finance share buy-backs
  • Acquire businesses at stretched valuations to boost growth

In this respect, Bettina Edmondson, global investment analyst at Saracen comments the following: AB Inbev’s net debt/EBITDA rose to 6.6x after the SABMiller acquisitions. Reckitt Benckiser bought Mead Johnson with debt (and equity) and geared up to 3.7x, while Danone’s leverage ratio reached 4.2x after it acquired WhiteWave. (Source)

In addition, many product categories have gone through unprecedented levels of disruption like coffee in capsules or craft beer. As a result, in most markets large brands have lost market shares to local incumbents and small insurgent brands. The impact of new small businesses is discussed in detail in the following chapter.

Let’s see what’s else that’s important to consider when investing into the consumer goods industry…

Market share and growth rate developments of small and large consumer goods brands

The following figure shows the change in market size between 2012 and 2016. Compared are small and large brands as well as private labels.

Soft drinks
In all considered countries, large brands have lost market share to small brands. Particularly strong in the UK with 12% and China with 9%. In Germany, however, no change is noticeable.

Packaged food
The largest shift in market share for packaged food took place in the United States, where large brands lost and small ones gained 6% market share. In Australia, private label are the winners of the fight for market share and thus could win 3%.

Beauty and personal care
For beauty and personal care products, large companies have on average lost 4% market share to small businesses in all countries.

Lost market share of consumer packaged goods firms

Let’s go one step further and look at the development of small (< $ 1 billion market capitalization), medium ($1 billion – $3 billion market capitalization) and large (> $ 3billion market capitalization) companies. We can see that the big losers are not the big consumer goods companies, but the medium-sized ones. Medium-sized manufactures lost 15% share of growth, while large companies increased their share of growth by 43%.

Thinking about the success of small manufactures, its quite simple. Consumer chose them, because they offer authenticity (The Body Shop), a connection to local growers (Cabot Creamery), the promise of healthy ingredients (Bob’s Red Mill and Annie’s Homegrown), or a quirky story (Ben & Jerry’s).

Sucess of small brands in consumer product sector

Thus, purely by looking at the size of consumer goods companies, we can identify rather promising companies to invest in and those, maybe not as promising. Overall, we should not only look at the products (discretionary vs. non-discretionary) that consumer goods companies are manufacturing, but also at the companies’s size. Doing so, you’ll be able to choose a suitable consumer goods company to invest in.

3 factors that determine future success of consumer goods companies

Besides a company’s size, there are many more factors that determine its future success. Further, if a company is successful, you as a potential shareholder are more likely to be part of that success story as well.

Thus, let’s take a look at three major factors that determine the future success of consumer goods companies. When you choose a consumer goods company you want to invest in, take a close look if it meets the following criteria:

1. Increase Globalization

  • To increase globalization it is important to drive growth and brand differentiation by expanding into global markets. For an expansion strategy the focus should be on emerging markets such as Asia, Middle East and South America. Consumer goods companies should focus on emerging markets because of the rise of global middle class to 5 billion people in 2030. (Source Brookings Institute) Especially the middle class in China will represent 70% of the whole Chinese population in 2030. The middle class will therefore consume more than $10 trillion in goods and services by then.
  • Besides focusing on emerging markets, consumer goods should be aware of their customer personas of the future. Specifically, there are two major consumer groups:
    • Expanding influence of women shoppers. According to GenAnalytics, in 2028 women will control 75% of household spending.
    • Expanding influence of younger generations. For example in India, 65% of the population is under the age of 35. In comparison, in the United States only 46%. Consumer businesses need to look at and track the trends of the younger generation. In addition, it is important to know the consumption behavior of the younger generation in the individual target markets in order to be able to sell products and services in a targeted manner. For example sell products in online shops, via Facebook or Instagram.
  • To accelerate globalization, it is advisable to partner with local companies. This has the advantage that local companies are better acquainted with the market and consumer behavior. Another advantage is that the distribution channels of the local company can be used and therefore also costs can be saved, which would have to be spent for the establishment of an own sales and distribution network. An example of a partnership with a local company is the cooperation between Unilever and Alibaba in China.

2. Bolder path to innovation for new approaches for market research, idea generation, or product development. In the era of fast changing consumer preferences and behavior, companies have to get a deep knowledge about the consumers wants and what consumers are willing to pay for a product or a service. With these insights the evolution of products and brands is targeted. There are two main approaches to strengthen innovation:

  • Setting up own venture capital units to invest in startups. For example Coca-Cola´s Venturing & Emerging Brands (NOS energy drink, Zico coconut water, …). Also L´Oréal has invested in the digital accelerator and incubator Founders Factory.
  • Using crowdsourcing to get direct ideas from customers for new product ideas and services. Also there is the possibility to test new products in a small circle of potential customers. For example Reckitt Benckiser teamed up with the crowdsourcing plattform Indiegogo.

3. Digital investments to better interact with customers and improve operations

  • Real-time customer engagement is key. Companies need to communicate directly with consumers, monitor social media conversations and respond in real time. More than 26% of purchases across product categories were spurred by social media recommendations. (Source)
  • Expanded e-commerce because online sales are experiencing a huge growth. From 2013 to 2018 online sales of consumer packaged goods increased 350% in comparison to sales in brick-and-mortar stores of just 3.6%. Consumers compare prices online. Thus, e-commerce sales can cannibalize sales through traditional channels. Besides increased sales, the shift to e-commerce helps to increasingly generate and access customer data. The more e-retailers sell, the more brands can learn about customers, enabling them to develop cross-sell and upsell strategies. To fully exploit data and analytics, companies must be able to choose and manage data from multiple sources, build models that turn the data into insights, and translate the insights into effective (inter-)action.

Source

Final Thoughts on which things to keep in mind before investing in the consumer goods sector

There you go: I have told you about the major characteristics and developments of the consumer goods sector. Now you know about the industry’s main driving forces and shifts expected in the future. This information is key to select suitable consumer goods companies to invest in.

Again, keep the following 3 points in mind:

  1. In the past, the consumer goods sector was a save harbor in periods of high market volatility or economic downturn. But there are signs that the future does not match the past.
  2. Emerging markets offer great potential for the future success of companies in the consumer goods sector.
  3. Investments in digitization, especially in e-commerce, are imperative to identify customer needs and to secure revenue growth.

Now I would like to hear from you..

Which stock of the consumer goods sector are you going to analyze or buy first? Do you think you will find some good investment opportunities?

Either way, let me know by leaving a comment below right now.

Thanks for reading this article. Please, let us know if you have feedback, corrections, or any further question (either down below in the comments or via contact). We are happy to discuss and further support you along your way to becoming a “yield reviewer”.

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