For years, consumer staples afforded investors a defensive hedge against periods of recession and stock market downturns. Their generous dividends, consistently increasing payout ratios and market dominance made them relativley immune to market volatility compared to other stocks in the S&P 500. These stocks were always part of the equity mix of every prudent long-term investor’s portfolio.
Bounty, Mr. Clean, Kleenex, Band Aids, all of these products for decades were well-known names that, through years of clever advertising, enjoyed unrivaled customer loyalty. These products were present in every household in the country.
Consumers didn’t mind paying a premium for these products because they were assured of quality and felt comfortable with purchasing a brand name. Indeed, so ubiquitous were the names of some of these products that, over time, some of the trademarks merged into descriptive nouns that became part of everyday vocabulary: Xerox, Band Aid, Kleenex. This phenomenon was indicative of these companies' established and unchallenged dominance in their respective markets.
The recent performance of the stocks in this sector, however, forebodes a very different future.
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, a new generation of consumers no longer exhibits the brand loyalty of their parents — a factor upon which these companies had always relied for the price inelasticity of their products.
Today, there are now a host of lower-cost comparable products available to consumers. Increasing competition and current consumer resistance to higher prices relative to other brands signals the sector's time-tested business strategy is no longer viable.
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.
Consider the following David versus Goliath tale that helps illustrate the current competitive predicament for many companies within the staples sector.
For decades, Gillette enjoyed a dominant position in the men’s razor and shaving products industry. It’s razors and cartridges were priced at a premium and stayed at that level for decades. Gillette razors were never cheap.
Recently, however, Gillette’s dominance in the shaving market has been challenged, perhaps inadvertently, by a brash, scrappy startup company called Harry’s, whose mail-order razors have successfully eroded Gillette’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.
Harry’s tiny ads initially appeared in the back of magazines; Gillette, was a darling of Madison Avenue. Today, Harry’s robust sales and growth are, in part, responsible for Gillette reducing the price of its razors. 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.
Another imperceptible factor that has impacted the market share of the 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.
The second-quarter results of consumer staple stocks were disappointing, and investors reacted accordingly. The stock of Kimberly-Clark (KMB, Financial) — maker of Kleenex — came close to hitting its 52-week bottom after its first-quarter sales failed to inspire investors. The rate of earnings growth of these large companies is slowing and investors are now reluctant to purchase shares of companies that were once sold as secure.
A look at Procter & Gamble's (PG, Financial) declining operating margins reflect the problems facing the staples sector.
After Procter & Gamble’s shares slid 3% on reported tepid sales growth, investors indiscriminately punished stocks sector-wide. The sector's tumbling shares pulled the S&P 500 lower. The sentiment is growing that these stocks can no longer be viewed as cornerstones of a well-balanced portfolio.
All of these signals indicate investors will have to readjust their defensive strategies because a previously sound and time-tested defensive play will no longer provide a safe harbor.
Disclosure: I have no positions in any of the stocks referenced in this article.
