Saturday, June 27, 2009 0 comments ++[ CLICK TO COMMENT ]++

Is this the end of the run for branded consumer goods?

Branded consumer goods have had a good run. They have done exceptionally well for the last few decades. In fact, one can argue they have been in a bull market of sorts since the 1950's—basically since the American post-war consumer boom started. Branded consumer goods companies also tend to have high ROE, supposedly strong moats, and are thought to be shareholder-friendly (they pay out a lot of their earnings as dividends.) But are we seeing the beginning of the end of their strong performance?

One of the arguments I often have with so-called value investors is their heavy reliance on branded consumer goods companies such as Kraft, P&G, Colgate-Palmolive, and so on. My feeling is that many pick those companies because they are influenced by Warren Buffett. I haven't seen many make any forward-looking bullish macro case for them (but then again, value investors usually don't try to make macro forecasts.)

I ran across a story from The Globe & Mail discussing how shoppers are becoming more frugal. I have seen similar stories elsewhere and I'm wondering if this may be the start of a trend. On top of declining consumption, private labels—these are store brands, sometimes called "no-name" products, with similar products at much lower price points—may be taking away market share.

William McComb, chief executive officer of Liz Claiborne Inc. calls the phenomenon the “savvy shopper syndrome”.

“It's not a matter of what can [a consumer] afford to spend, it's what's the price that she can get it at,” Mr. McComb said at a recent retail conference.

“And that's something that just emerged out of nowhere,” he added.

Sales of private label products are also soaring, putting more pressure on brand-name makers to cut prices or spend heavily on marketing.

Retailers are also slashing the number of brand names they carry in order to make room for their own varieties.

This week, U.S. grocery store giant Kroger Co. reported a 13-per-cent increase in quarterly profit thanks mainly to a big jump in sales of its private label offerings.


The newspaper story is kind of biased. It only looks at opinions from frugal shoppers and so it may be somewhat misleading. Nevertheless, one just wonders if this is the start of a trend.

The real question is not what happens during the current recession (although short-term investors would probably pay attention to that.) Instead, what really matters is whether American shoppers have permanently changed their shopping behaviour. Will they avoid paying a higher price, and instead, move to the cheaper private-label brands? It remains to be seen. I'm somewhat bearish on branded consumer goods companies and would be careful at current valuations (most of them have consistently traded at above-market multiples for the last few years.) The risk is not that these companies will go bankrupt but that their profit margins will contract.





SIDE NOTE:

Some that are bullish on branded consumer goods companies argue that a lot of the income is foreign and there is growth potential in emerging markets. It is generally true that these companies depend quite a bit on foreign sales. Yet, I remember looking at several of them a while ago and I noticed that they still depend heavily on the developed world. Even when off-shore sales were more than 50%, a lot of it came from Europe and Japan, two areas seeing weakness. If the core market declines, they will face issues no matter how well the (smaller) foreign markets are.

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