Good news for South Africa’s ‘disappointing’ sector

The consumer staples sector has historically had a disappointing performance, but there may be an opportunity for investors

This was explained by Allan Gray portfolio manager Kamal Govan, who said that consumer staples include goods like groceries, beverages, and home and personal care items.

He said these products are widely recognised, but they have underperformed the broader market (MSCI World Index) over the last decade. 

“As the adage goes, a good business is not necessarily a good investment. The global consumer staples sector has underperformed the market, represented by the MSCI World Index, over 10 years,” Govan said. 

“In fact, the performance of many consumer staple stocks has been disappointing over most time periods since the turn of the millennium.”

He added that the industry is also faced with a number of risks. These include:

• Price affordability: Balancing pricing power with affordability is crucial for those with outsized exposure to the mass market, such as consumer brands.
• Competition: Technology, private-label brands, and smaller, local brands are intensifying competition.
• Changing consumption habits: Consumer preferences are changing, and brands need to keep up with this shift. For example, the recent rise of weight-loss drugs may affect products like sugary drinks and packaged foods. 
• Operational complexity: Managing global operations with diverse regulations and currencies adds challenges.

Despite this, the sector is considered a defensive investment due to its stability, consistent earnings, and dividend payouts, which provide shelter during economic downturns.

Historically, consumer goods have significantly and rapidly outperformed during periods of economic stress. 

“A deeper look at the period around the dotcom crash provides an example of how these stocks perform under economic stress,” Govan explained. 

“Consumer staples and other defensive sectors, such as utilities, telecoms, healthcare and technology, underperformed in the build-up to the dotcom peak on 27 March 2000, however, these same sectors witnessed massive outperformance when the bubble burst.”

According to Govan, businesses operating in this space have a number of key characteristics which make them more resilient during economic downturns.

“Consumers buy staple products in good times and in bad, meaning that these businesses are less exposed to cyclical changes in demand.”

These companies own well-known global and local brands that consumers trust, and as a result, they often make purchases without much thought. Strong brands create loyalty and make it hard for customers to switch to competitors.

Popular brands can raise prices without losing customers. By investing in and maintaining strong brands, these businesses ensure steady profits, even during tough economic times. Even when prices of these products increase, demand remains steady.

Large consumer staples companies also manage complex global operations, which gives them bargaining power over suppliers, allows them to control costs, and allows them to dominate store shelves.

Govan added that when investing in consumer staple stocks, it’s important to consider where we are in the interest rate cycle. 

These stocks are often seen as a substitute for bonds because they offer stable and high dividend yields. When interest rates are high, investors may prefer bonds over consumer staples. 

But when interest rates are low, the steady dividends from consumer staples become more attractive. Right now, interest rates are expected to decrease, which could make consumer staples more appealing.

Historically, consumer staples have outperformed during economic stress, offering stability when other sectors struggle, especially in times of market crashes (e.g., the dot-com bubble). 

Additionally, the sector often mimics bond-like behaviour due to its stable dividends, which are more attractive during periods of low interest rates.

The Allan Gray Balanced Fund has exposure to both local and offshore consumer goods, Govan said.

Key stocks in the Allan Gray Balanced Fund include:

• British American Tobacco: Discounted due to slowing tobacco use, but with potential from next-generation products and reduced debt.
• AB InBev: Margins should improve as commodity costs ease and premium beer brands grow.
• Asahi: Positioned for growth from premium beer markets in Europe and Oceania.
• Unilever: Benefits from focusing on core “power brands,” with expanding margins and shareholder returns.
• Tiger Brands: Upside potential from a turnaround strategy in South Africa, dependent on economic recovery.

For investors looking to add consumer staples to their portfolios, a strategy of bottom-up investing in undervalued consumer staples stocks with the potential for improved performance may be a good approach.