Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 283

Don't overlook the quality in consumer staples

Although they have commanded little attention recently, consumer staples companies such as food and beverage groups are a core part of global equity portfolios. These companies have underperformed perceived growth sectors such as information technology and health care, but they are generally considered quality companies whose share prices have lower volatility than more cyclical companies. For many of these companies, the characteristics that cause them to be considered quality companies are the same ones that enable them to score well on standard ethical investing criteria.

After a period of investor attention in the five years following the 2008-2009 financial crisis, consumer staples companies have fallen off the radar of many investors. Their performance, particularly in the past 12 months, has been sluggish, as shown in the chart below. Most global equity investors – particularly those focused on future earnings growth – have turned to companies in the information technology, healthcare, and consumer discretionary sectors, which collectively appear to be signalling the likely sources of economic focus in decades to come.

MSCI Consumer Staples versus MSCI World, 1995-2018

Source: Bloomberg, Whitehelm Advisers

But consumer staples companies have not gone away. From an economic perspective, most are as large as ever, and the products they provide are for the most part still considered essential.

Consumer staples defined

There are two definitions of consumer staples. The first is essential products, such as food, beverages, and household items. That is a relatively broad definition. The second, however, is goods or services that people are unable or unwilling to cut out of their budgets regardless of their financial situation. This textbook definition of inelastic demand is the one that investors pay most attention to. Consumer staples sell in all economic conditions.

Virtually all global consumer staples companies have consistent year-over-year net profits and dividends, and as shown below, they also have other characteristics associated with quality companies: relatively high operating margins, low debt and a low cost of capital.

Financial summary for selected consumer staples food groups

The beverage group of consumer staples companies – alcoholic and non-alcoholic – shares many of the same characteristics of consumer staples food groups: stable earnings, generous profit margins (even after government taxes), low debt, and high intangible assets.

Financial summary for selected consumer staples beverage groups

Australian consumer staples companies are different, however. The long, inexorable march toward convenience-oriented food over the past 70 years did not develop as fully as in other developed countries, particularly North America and northern Europe. This is reflected clearly in the consumer staples segment of Australian stocks within the ASX200. The main constituents of the index are large integrated grocery chains and specific health and nutrition companies, including vitamin and infant health companies.

On the surface, it might be considered unfortunate that whole other sectors of the Australian food-producing economy are essentially uninvestable to listed equity investors, but perhaps it is a blessing in disguise, since many of these businesses are highly cyclical in nature, whereas consumer staples companies are generally very stable.

Threats to food and beverage consumer staples companies

A company like a consumer staples food or beverage producer may be attractive to investors because of its stable revenues and relatively high operating profit margins. Such a company may also be attractive from an ethical investing perspective because of its focus on providing essential products without harmful effects. Just as consumer preferences and collective beliefs change over time, however, so does the financial landscape in which these companies operate. A company that has comfortable profit margins, stable earnings, low debt, and a low cost of capital, with diverse brands and a focus on adhering to ethical standards may grow too comfortable. For an activist investor, a consumer staples company could have higher operating profit, higher debt, and more dynamic management. The very things that have made it a quality company are on the way to making it a mediocre company, and one vulnerable to outside shareholder action. This action may come either through activist investing - agitating for change from the outside, typically through board representation - or alternatively from a takeover of the company’s management, and an accompanying efficiency drive. That is essentially what 3G, a consumer food and beverages group originally based in Brazil, has done sequentially with the world’s largest beer company, Anhauser Busch InBev, and with KraftHeinz, the US food products company.

A second financial threat to the consumer staples group is consumer preferences themselves. This has manifested itself in static or falling revenues. While the low growth and low inflation environment of many developed world countries since the 2008-2009 financial crisis does not make this particularly surprising, a number of consumer food groups are experiencing declining revenues, or revenues that would be declining if not for growth in developing country sales. In most cases, however, consumer staples company sales are declining not only due to low economic growth, but also due to consumer preferences that do not match what the companies are producing.

In response, only a minority of large consumer staples companies have taken the 3G approach of attempting to make operations significantly more efficient, however. The first response of consumer staples companies to falling sales has instead been to acquire smaller companies. For the most part, however, these absorptions have only stopped revenues from falling further, rather than increasing them. A minority of companies have continued to focus on increasing sales organically, rather than through continued acquisitions. A common theme has been a focus not on reducing costs, but on increasing sales through reinvestment in brands, employees and research. Whether doing so can be considered more advisable, however, is an open question.

Australian institutional investors collectively own a large amount of consumer staples companies both inside and outside Australia and will likely own more in the future. Even today, a single Australian investor is one of the largest shareholders in several global consumer staples food groups. As their collective influence grows, Australian investors might consider teaching the rest of the world the lessons that they have learned about how companies can balance the competing concerns of investor, consumer and shareholder objectives.

 

John O'Brien is a Principal Adviser at Whitehelm Capital, an affiliate of Fidante Partners. This article is for general information purposes only and does not consider the circumstances of any investor.

Fidante is a sponsor of Cuffelinks. For more articles and papers from Fidante, please click here.

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.