For decades, consumer staples have been reliable defensive stocks in periods of economic downturn or market turbulence. Investors flocked to the sector because of the stocks' generous and stable dividends and the price elasticity the companies' brand products commanded due to long-term consumer loyalty.
Today, there are several factors that are going to dramatically disrupt the staples sector, which will change the relative appeal of consumer product companies as the second decade of the 21st century looms.
One of the factors that will make staples stocks less attractive is the end of the era of historically unprecedented low interest rates. Although the consumer staples sector carries a current dividend rate of approximately 3.07%, which bests the S&P 500’s 1.99% yield and is slightly higher than 2.712% yield on the 10-year U.S. Treasury note, rates hit the 3% mark for the first time in a decade earlier in the year.
During the zero-interest rate environment that prevailed over the past decade, consumer staples were alluring to yield-starved investors because of their stable dividends. Due to few alternatives available for income-oriented investors, the price-earnings ratios for the staples stocks rose to the mid-20s or higher. After three consecutive interest rate hikes from the Federal Reserve, the staples stocks no longer are havens for those investors seeking the highest available yields. Bonds and other short-term vehicles are now becoming, for the first time in 10 years, a viable income-generating alternative.
Another factor is the changing nature of consumer purchasing habits, as well as a diminishment in brand loyalty and the unfettered ability to raise product prices, even in recessionary periods. For decades, earnings stability of the consumer staples sector was due to the fact companies could increase the price of their products without fearing a consumer exodus. Today, there are now a host of lower-cost comparable products available to consumers. The new marketplace and changing shopping habits of consumers will continue to erode operating margins for the large staples sector.
This new reality has been recently reflected in disappointing revenue growth figures reported for the first and second quarters of 2018. Although many of the staples companies recently announced price increases for 2019 to maintain margins, these increases may prove fleeting as they are still vulnerable to losing customers in an economic downturn who may balk at paying higher prices.
As I noted in an earlier article, the steady decline in razor sales for Procter & Gamble's PG Gillette is symptomatic of the challenges facing the entire staples sector. For decades, brand enjoyed a dominant position in the men’s razor and shaving products industry. Its razors and cartridges were priced at a premium and stayed at that level for decades. Gillette razors were never cheap.
Gillette’s dominance in the shaving market has been challenged, perhaps inadvertently, by brash, scrappy startup companies called Harry’s and Dollar Shave Club, whose mail order razors have successfully eroded the giant’s once insurmountable market share. Many men, tired of the price-gouging for a simple cartridge razor, were only too happy to jettison Gillette when a comparable product appeared at a substantially lower price. For almost a century, Gillette was synonymous with shaving products and priced its products accordingly. In the new millennium, that will no longer be the case.
In a year-end interview with Barron’s, Rupal J. Bhansali, equities portfolio manager for Ariel Investments, had similar sentiments concerning the lesson to be learned from Gillette’s loss of pricing power due to defections to alternative razor companies.
“The industry’s yesteryear playbook of relying on distribution strength, brand and pricing power, and customer segmentation is going to get upended," he said. "The market isn’t paying sufficient attention to this long-term risk.”
Another imperceptible factor that has impacted the market share of consumer product companies is the advent and utility of the internet. Online payment processing has now made ordering by mail and through websites painless and efficient. This is one of the reasons for Harry’s success over the Gillette Goliath. As Bhansali correctly notes, “The consumer-staples sector hasn’t prepared itself for the onslaught of price transparency in an online, digital, e-commerce world, which is the opposite of the bricks-and-mortar world in which one can price- discriminate by customer segment and distribution channel.”
A new generation of consumers no longer exhibit the brand loyalty of their parents, which was one of the predominate factors that allowed staple companies to enjoy price elasticity for their products.
A telling example of a century-old staples company whose business strategy, in part, is still wedded to the past is Campbell Soup CPB. Even though the company has provided consumers with more choices, in most supermarkets there remains the ubiquitous stack of Campbell soup cans from the days of old; all of the cans lined up in neat rows, like soldiers awaiting review, sporting the same red and gold uniforms worn since the time Washington crossed the Delaware.
This assessment of the company’s fledgling business model is buttressed by the price of its stock, which has dropped substantially over the past 12 months, losing 25% of its value.
Perhaps as a harbinger to come, the staples sector performed poorly in January, logging a 3.1% gain, underperforming the 7% gain for the S&P 500. As if to foretell the coming transformation of the industry, fourth-quarter profits for consumer staples stocks are projected to be one of the weakest of the 11 sectors in the S&P 500, increasing just 3.6% versus an anticipated 11% gain for the broader market.
Disclosure: I have no positions in any of the securities referenced in this article.
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