Markets & Research
In some ways, the consumer staples sector is the minivan of the equity world — steady, reliable and decidedly unglamorous. But as with the multipurpose family vehicle, it can be all too easy to overlook the sector’s many appealing attributes.
Consumer staples companies churn out everyday necessities that people buy regardless of economic conditions, such as food and household products. These businesses tend to have solid earnings and dividend-paying cultures. And the sector has historically been defensive, providing comparative refuge during periods of stock market turmoil. These traits are always attractive, and perhaps never more so than at an advanced stage of the economic cycle.
Beyond these features, consumer staples companies are at the forefront of several global trends, including the ongoing rise in emerging market living standards and the burgeoning preference for upscale products among consumers around the world. Though these items are higher priced, buyers view them as affordable luxuries that are high in quality and confer a certain cachet. Premiumization, as it’s known, is an important current flowing through industries, such as cosmetics, liquor and food.
Of course, the prospects for some companies are much brighter than for others, and the ability to identify the most promising businesses is critically important. Some segments of the sector are grappling with limited pricing power and lukewarm organic growth. And in a world where online arbiters wield sizable cultural influence, businesses of all stripes must contend with rapid swings in consumer tastes.
Nevertheless, companies with global franchises and prominent brands have distinct advantages, according to Capital Group Private Client Services analysts. These companies tend to have pricing power, high margins and the marketing muscle needed to maintain customer awareness in an oversaturated retail ecosystem. Consumer staples businesses don’t boast the explosive profit growth of some other sectors, but the durability of their earnings can persist through fluctuations in economic and market cycles.
“Most companies have good exposure to the growth potential of emerging markets,” says analyst Saurav Jain, who follows European food producers and household personal products. “And because their earnings are resilient and balance sheets are strong, these companies tend to fare better in downturns than other industries.”
Despite China’s sluggish economy and the current trade clash with the U.S., the Asian giant is expected to remain a powerful source of growth. Though economic uncertainty could dent consumer confidence in the near term, the appetite for premium products among China’s expanding middle class is likely to keep accelerating. Practical considerations and the aspirational nature of the products are driving a secular shift to higher-level offerings.
This is evident in the cosmetics industry, where China is generating more than 50% of growth for global companies. Chinese consumers differ in key ways from their U.S. counterparts, says cosmetics analyst Joyce Ye. There is a greater cultural emphasis on skin care, customers begin to use premium products at younger ages and shoppers are willing to pay for aspirational brands.
“People care about their skin and their overall health, and they see these products as important,” Ye says. “Demand is structural rather than a passing fad.”
The appeal of higher-quality offerings extends to other industries. Parents, for example, want the most absorbent diapers and the most nutritious baby formula for their children. Chinese homeowners, meanwhile, yearn for appliances that make their lives easier, such as dishwashers and clothes dryers. With fewer than 2% of urban households owning a dishwasher, sales ballooned 88% in China last year and are expected to surge an additional 40% this year.
Beyond emerging markets, premiumization is a global phenomenon. For example, consumers throughout the developed world are turning to upmarket liquors. “Instead of having three or four drinks when they go out for dinner, people will have one or two,” notes beverage analyst Archana Basi. “They’re willing to pay more for them because the taste is better.”
Visionary management is a key differentiator.
Savvy management is essential given the challenges posed by shifting consumer tastes and other forces. The food industry, for example, tends to be among the most defensive in the staples sector. But it is being buffeted by consumers’ affection for organic and plant-based offerings. Some businesses are better positioned for this trend than others.
Overall, the outlook is promising for companies with enduring brands and management teams that are adept at spotting trends around the globe.
“Strong managers can galvanize growth by targeting the right categories, making prudent acquisitions and disposing of weak product lines,” Jain says. “A good CEO can have a transformational effect on a consumer staples company.”
The above article originally appeared in the Summer 2019 issue of Quarterly Insights magazine.