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Are consumer goods brands running low on power?

Equity Analyst Sophie Lund-Yates assesses the challenges faced by some of the biggest fast moving consumer goods companies (FMCG), and what it means for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

It’s never been easier to launch a brand. But creating lasting brand power has become a lot more difficult.

That’s a big headache for fast moving consumer goods (FMCG) companies like Unilever, which relies on people choosing its branded toiletries, food and cleaning products to support higher margins. Think Dove soap and PG Tips. Sales for these companies are steady rather than spectacular, and in some cases even slower than expected.

What’s causing the shakeup in consumer goods? How much of a problem is it for the big names? And what can investors do about it?

This article is not personal advice. All investments and the income they produce can fall as well as rise so you could make a loss. If you are at all unsure whether an investment is right for you, seek advice.

Diagnosing the problem

Digital marketing has transformed how new brands understand and interact with potential customers. Where brand launches used to mean billboards, TV adverts and newspaper inches, now some well placed internet ads can do the job.

That’s made launching new brands much cheaper and reduced barriers to entry. As a result, smaller companies have been able to eat into established names’ market share.

The explosion of new brands has also segmented the market. Younger consumers have become more discerning about what they buy. They’re choosing to engage with more ethical products, as well as those that feel more premium or unique. Meanwhile low-cost alternatives like Aldi and Primark are scooping up demand from the more price conscious.

That makes it more difficult for a few brands to dominate a market. Smaller, more agile companies, armed with digital data, have been able to capitalise on these trends.

One of the best examples of this disruption is the rocket-fuelled rise of Fevertree. The tonic industry wouldn’t have sounded too exciting a few years ago. But the biggest names were caught napping. It took just 13 years for Fevertree to steal over 40% of retail market share from other mixers.

Mixer brand market share 2018 (UK retail)

Source: Fevertree Annual Report 2018

Big companies also have to contend with ecommerce. Mushrooming sales on sites offering cross-category items, like Amazon, mean people aren’t just hopping online for something specific. Ecommerce has changed whole consumer journeys and decision making. That interferes with the supermarket aisle-browsing model FMCG brands have relied on in the past.

These online giants also pile pressure on prices, often offering affordable own brand alternatives.

The rise of private label is perhaps even more noticeable in supermarkets. This will impact some products more than others – we still think it would take a lot for someone to swap from Marmite to a supermarket’s own yeast extract. But we see this as being more of an issue for things like cleaning products, which could be a headwind for Lysol maker, Reckitt Benckiser.

The net effect of all these challenges is stagnant or falling volumes at some of the major FMCG companies. While higher prices have been used to make up the volume difference there’s only so far you can squeeze that particular orange before the pips start to squeak and profits are hit. These are issues we look at in more detail in our share research, which you can sign up to here.

What’s the good news?

We’re not saying the likes of Unilever or Reckitt are doomed. These are giants. A huge chunk of the world’s population use their products daily, and they have some hefty tools available to fight those encroaching on their territory.

The first of these is deep pockets. Unilever, for example, has over 6,000 people solely dedicated to researching and developing products. It spends around €1bn a year on R&D.

This matters because product innovation helps justify price increases, which in turn should help margins. Some of the extra profit can then be reinvested in next year's marketing budget, keeping the virtuous cycle going.

The other lever the big players can pull is M&A (mergers and acquisitions). Getting rid of underperforming brands or acquiring new and exciting ones is a way for these companies to keep ahead of the competition. M&A activity can provide some serious upside. Take Reckitt as an example. In 2018, pro-forma revenue grew just 3%, but once the impact of mergers and acquisitions was taken into account, that number swelled to 12%.

Being the biggest on the playing field gives you options, including the resources to adapt or double-down efforts. But it can also make change a more cumbersome process. These giants often have large fixed cost bases, primed to service billions in steadily growing sales. Any major shakeup to that modus operandi can’t happen overnight, and could be uncomfortable.

Overall, we think the big consumer goods groups have the tools available to compete with newer rivals. But meaningful profit growth will require using those tools efficiently to boost innovation and agility and keep younger brands on their toes.

What can investors do?

A lot of the companies we’ve talked about still offer investors opportunity. But for a slightly different way to get exposure to the consumer sector, discount general retailer B&M could be worth a closer look.

The group’s able to capitalise on weakening brand power, because of the newfound willingness of brands to accept lower prices in certain settings. It’s difficult to imagine “superior” brands allowing themselves to be found on a discounter’s shelves ten or twenty years ago.

B&M is able to charge lower prices because it buys a large number, but small variety, of branded goods direct from factories. By following that “pile it high sell it cheap” method, B&M is able to maintain a gross profit margin (revenue minus cost of goods sold) in the mid-thirties, in line with most peers.

Its approach helps keep wider costs low too, and operating profits have come along for the ride, rising from £182.1m in 2016, to a projected £289.8m in 2020. Remember though, past performance isn’t a guide to the future.

It should be remembered the European retail environment has been difficult, and there’s a strategic review underway in the German business.

The more important UK market (which accounts for about 87% of revenue) has seen like-for-like sales stagnate a little too as competitive pressures hit. 2020 has got off to a more positive start though, and B&M’s still doing better than some peers, with like-for-like sales hanging on in positive territory.

Still, there are challenges. The retail environment is brimming with tough competition, meaning a continued softening of sales performance can’t be ruled out entirely. Those question marks help explain why the shares change hands for 15.8 times expected earnings, below the long-term average of 19.4.

We think B&M has an attractive business model and could be well placed to capture discount-minded consumers in the longer term, but there are no guarantees.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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