Pricing Power is not Infinite
In difficult market environments, Consumer Staple (CS) stocks are assumed by most investors to be a safe haven. They are considered part of a group of “defensive sectors” due to the consistency of the underlying business regardless of the economic environment and they include Healthcare and Utilities, to name a few. This is why CS stocks are often sought out during periods of worry such as:
- Inflation – essential products consumers can’t live without regardless of price.
- Recession – consumers will prioritize spending on the basics in tough times.
- Volatility – stick with these “steady eddy” earners for a smooth ride.
It would seem that Consumer Staples are the true superheroes of the stocks market, able to overcome any macro headwind in a single bound! However, more recently, CS stocks seem to be misbehaving – actually leading indices lower during a period of increased volatility.
Maybe they’ve reached the limit of their pricing power. Using the “cover” of inflation, many consumer product companies steadily increased prices or shrank portion sizes to keep their revenues growing and protect their margins. For most, this masked the real problem – lower volumes from consumers exhausting their appetite for products like Oreos™ and Doritos™. This “price creep” sustained itself much longer than we expected, which we pointed out in our August 2022 blog titled: Is the Market Crying Wolf on Long-Term Inflation?
Consumer Staples companies have a remarkably resilient job market, higher wages and a government-fueled savings pool to thank for their record profits. However, over time, they must add incremental value and/or deliver novel features in order to justify a higher price. This is especially true in light of increased competition from private label alternatives – in fact, large wholesalers like Amazon, Costco, Target and Walmart have increasingly made upping their percentage of in-house sales a priority.
Novo Nordisk’s is a good example of a company who is adding incremental value and delivering novel features with its GLP-1 inhibitor – a blockbuster weight loss drug that goes by the name Ozempic and Wegovy. This game changing treatment, along with Eli Lilly’s Monjaro, is expected to change the lives of millions of Americans, taming their appetite for food, drink — and snacking. Smaller portion sizes and more infrequent meals could have a meaningful impact on the bottom lines of many food, beverage, restaurant, and general merchandise stocks. According to a Bloomberg article (Ozempic Is Making People Buy Less Food, Walmart Says), in a recent interview the CEO of Walmart indicated that consumers who were prescribed these medications saw a “slight pullback in the overall basket” relative to the general population. We will leave it to the reader to decide whether it’s appropriate or not for Walmart to data mine your prescriptions to understand your buying patterns.
Even Apple – perhaps, the best consumer brand ever – may not be immune to the changing behavior of consumers. Phone volumes are down. Is the ever-extending replacement cycle finally showing up in their results? And as the wireless carriers struggle to fund continued 5G rollouts, will they be able to subsidize phone purchases indefinitely? Probably not. Don’t get us wrong, Apple is still a cash machine unlike any we have seen in history. But it’s not a growth story, and at 28.2x Forward P/E multiple (a 43% premium to the S&P 500 Index’s Forward P/E multiple of 19.7x), it’s an expensive way to access safety.
At the end of the day, you are better off choosing stocks that not only play defense but offense as well. These are secular growth stocks and you need them in your portfolio because of their real ability to consistently deliver growth regardless of the economic backdrop. And be sure to read this blog we wrote about secular growth that is especially meaningful during this difficult market environment.
Validus holdings include Novo Nordisk and Eli Lilly in composites used within individual client portfolios. Securities highlighted or discussed in this blog have been selected to illustrate Validus’s investment approach and/or market outlook and are not intended to represent any strategy or portfolio performance or be an indicator for how strategy or portfolio have performed or may perform in the future. Each security discussed in this blog has been selected solely for this purpose and has not been selected on the basis of performance or any performance-related criteria. The securities discussed herein do not represent an entire portfolio and, in aggregate, may only represent a small percentage of a strategy or portfolio holdings. The strategies and portfolios are actively managed, and securities discussed in this blog may or may not be held in such strategies or portfolios at any given time. These individual securities do not represent all the securities purchased, sold, or recommended and the reader should not assume that investments in the securities identified and discussed were or will be profitable. Nothing in this blog shall constitute a recommendation or endorsement to buy or sell any security or other financial instrument referenced in this letter.
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