Key Takeaways
- The consumer staples sector tends to be resilient to changing economic conditions, making it a relative ‘safe haven’ during a recession.
- Inflation’s a key trend to monitor over the short term, as companies without brand power will likely struggle if it stays high.
- Consumer staples covers a wide range of businesses, so it’s important to understand the specifics of the company you’re investing in.
What is the consumer staples sector?
The consumer staples sector covers businesses that provide essential goods and services which consumers typically use on a daily basis. This includes a wide range of items like food and beverages, household goods, personal hygiene products, over-the-counter medicines, and even alcohol and tobacco.
This sector is non-cyclical, meaning demand for these products tends to remain relatively constant all year round, regardless of product price or the health of the broader economy. This typically leads to more stable and predictable earnings, which can be a comfort to investors when a recession hits.
Their ‘safe haven’ status also feeds into these companies being able to offer healthier and more reliable dividends. Though as with any investment, nothing is guaranteed.
How has the sector performed?
Over the past five years, the UK consumer staples sector has moved broadly in line with the wider market. That’s because consumers view these products as necessities rather than just ‘nice-to-haves’.
UK consumer staples sector performance
Past performance isn’t a guide to the future. Source: Refinitiv Eikon, 10/05/23 (consumer staples sector represented by the Refinitiv UK Consumer Staples Index).
So even in tough times when the economy stumbles or disposable incomes are getting stretched, these items are typically the last thing you’d leave out the shopping basket.
You can see this in the above graph. In 2020, the pandemic upset normal business conditions. As a result, the wider market clearly underperformed relative to the ‘defensive’ consumer staples sector – shown by the only major divergence of the two indices across this five-year period. Past performance isn’t a guide to the future.
On the flip side, when the economy’s healthy and consumers’ wallets are bulging, growth’s likely to be unspectacular. That’s showcased by the sector line tracking closely with the wider market over the rest of this five-year period. It turns out, even in good times, there’s only so much food or deodorant one needs to buy.
Zooming in on the past year
Over the past 12 months, we’ve seen inflation running hot around double-digit levels. Meanwhile unemployment rates have been near historic lows. And to top it off, consumers have had higher levels of savings thanks to prior lockdowns curtailing normal spending habits. All of this meant consumers have been better able to stomach higher prices at the grocery stores.
The fact that price hikes touched just about every corner of our lives made consumers more accustomed to them, and therefore less likely to trade down to cheaper alternatives. As a result, lots of consumer staples companies were able raise prices without losing customers.
What are the biggest opportunities?
Looking forward, we think consumers will become increasingly sensitive to further price hikes – especially if savings levels dwindle and if unemployment rises.
And while there are typically no substitutes for consumer staples goods, consumers have a lot of options when shopping for the cheapest version of a product.
That’s where brand power comes in. Those best positioned within the sector will have strong brand power – allowing them to continue raising prices further without denting sales volumes.
The consumer healthcare industry stands out to us as an area where consumers display strong brand loyalty. Customers tend to be happy to stomach a higher price when it comes to over-the-counter medicines they trust.
The beverages industry is another area that’s caught our eye. There’s a lot of consolidation in the industry, high barriers to entry, and only a handful of big players of scale. This dominance gives them pricing power to help offset cost inflation. And these companies have plenty of experience introducing new products at a price point they know the consumer is willing to pay.
The sector’s filled with plenty of large multinational companies. This means their revenues are spread across lots of different parts of the world which helps to diversify some risk if certain areas underperform for any reason.
While in the main, growth’s likely to be slow and steady, there are some cherries to pick within the sector. Companies with exposure to emerging markets have potential to benefit over the long term but they can also carry additional risks.
What are the biggest risks?
The sector is filled with large and mature companies, and the demand for their products typically remains stable. But that means any future growth is unlikely to shoot the lights out. It’s the hidden price you pay for some stability in uncertain times. And if there happens to be an economic upswing, other areas of the market are likely to benefit more than this sector.
No matter what way the economy swings, ongoing supply constraints will likely continue to be a thorn in this sector’s side. While the worst of the problems might have passed, supply chains are still under pressure.
Freight costs are heading in the right direction, but we’re still seeing difficulties in the availability of truck drivers, trucking capacity, and shipping delays at ports. All of which have negative effects on companies being able to get products on shelves – ultimately hurting profits.
It’s also worth keeping in mind that not all consumer staples companies are created equal when it comes to brand power. If the cost-of-living crisis continues to bite into consumers’ budgets, those companies with weaker brand power are likely to lose sales as customers trade down to cheaper private-label products.
Changing consumer preferences is also a trend to keep an eye on. For example, the decline in smoking is an area which the tobacco industry is going to have to wrestle with in the coming years.
Recessionary fears have been looming overhead for some time now. Many investors have already flocked to this sector for its historical ability to hold up better than most during a downturn. That means valuations need to be considered on an individual company basis, as a lot of these defensive benefits are already priced in to most corners of the sector.
Our view
The consumer staples sector has held up well given the rollercoaster ride of events over the past few years.
As with most sectors in the current environment, inflation’s still a key metric to keep an eye on. If it remains sticky throughout the rest of the year, we could see consumers trading down to cheaper private-label goods. That means it’s important to consider brand power in any investment decisions.
Given the diverse scope of the sector, ranging from baby wipes to cigarettes, valuations need to be compared against a peer group rather than the sector average. The price-to-earnings ratio of a tobacco company will be very different to a beverages company.
Ultimately, most consumer staples companies should be less sensitive to changes in the health of the economy. A lot of the defensive benefits look to be priced in already, but we still think certain pockets within the sector look attractive on a long-term view.
As always, remember investments and any income from them can fall as well as rise in value so you could get back less than you invest. This isn’t personal advice – if you’re not sure what to do, ask for advice. Past performance isn’t a guide to the future.
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