Further Exploring the Resilience of Consumer Staples with Ash Park’s Jon Fell

Last December, I discussed the long history of resilience of Consumer Staples stocks with my friend, Jon Fell, of Ash Park.  I invited Jon back to build on that conversation, and below we discuss, among other things, the impact of inflation on consumer staples stocks, and what have been good examples of failures within the industry.

In the first blog we featured the chart showing the multiple one could have paid for some great Consumer Staples companies in 1973, and still made a 7% annual return (excluding dividends) – slightly better than the market – over the next 46 years. A common push-back is that the chart illustrates survivor bias, and that overvalued losers are missing. Is that fair?

JF:  We wondered about that as well, so we checked it. A few years ago we dug out the stats for all the US and European branded Consumer Staples stocks which had a market cap of $173m or more in January 1973 (equivalent to $1bn in today’s money). Outside the 25 surviving companies we featured in the original work, we found a further 41 which met the market cap threshold and have since disappeared because they’ve been acquired or merged.

Of those 41, 27 (66%) outperformed the US market up to the point at which they were bought. If you add those figures to the 21 surviving companies which had market caps over $173m in 1973, of which only Avon hasn’t outperformed, that’s outperformance from 76% of the 1973 universe.[1]

Figure 1: Performance relative to the US market up to the point of acquisition

Performance annualised in US$, calculated from 1st January 1973 up to the point of acquisition; includes gross dividends.
Numbers above bars indicate numbers of years of trading history from Jan 73

Source: Ash Park / Refinitiv Datastream

Going into the detail of the underperformers is interesting too. There are four where the underperformance was pretty marginal and the absolute returns OK: Beatrice Companies (a 9.2% annualised absolute return for 13 years), Revlon (7.3% annualised for 13 years), Borden (9.6% for 22 years) and United Biscuits (10.8% annually over 27 years).

And there are four real disasters, all of them brewers. Two (Brau und Brunnen and Actris) were from Germany, where brewing is a famously-tough business (lots of small family brewers who don’t consolidate).

Then there are two US brewers, Schlitz and Pabst. The Schlitz tale is a bit of a classic: in 1976 they were only just smaller than Anheuser-Busch, with a US market share of around 16%. The Uihlein family which wanted to overtake A-B again needed increased capacity, but decided to cut corners: rather than investing in capex they chose to reduce the brewing cycle (to 14 days, v A-B on nearly 40), having already reduced the beer’s malt content. But with lager, if you reduce the ageing time you also require more stabilizers to stop solids being formed when proteins blend with the tannins in the beer; those solids look like mucus and float around in the bottle. In 1976 they changed the stabilizer they were using, and unfortunately that accelerated the production of solids. Schlitz waited a long time before doing a product recall, and sales tanked because people didn’t want beer with mucus floating around in it. They followed that up with one of the worst advertising campaigns of all time, which became known as “Drink Schlitz or I’ll kill you”.

Schlitz’s decline continued, and eventually they were sold to Stroh in 1982 as a shadow of their former selves. Pabst’s downfall was largely due to sins of omission rather than commission: they lacked the marketing dollars to compete effectively in the mainstream, and failed to launch a light beer in time to compete with Miller Lite and Bud Light.

Carter Wallace, which was a personal and healthcare company broken up in 2001 by Church & Dwight and a private equity firm, looks very bad on the relative performance but in fact did an OK-if-pedestrian 6% absolute return for 28 years (a positive real return of 0.8%). It was hit mostly by problems it had with its pharmaceutical operations in the early / mid 90s – the FDA started investigating its cough medicines in March 1992, suspecting they could be carcinogenic, and then in 1994 it had to withdraw a new epilepsy drug, Felbatol, after several patients died.

Of course we’re not saying that you should pay any multiple you like for one of these companies and just hold forever; we know that’s not realistic. The point we’re trying to make with our original chart is that the market is generally very poor at recognizing the longevity of cash flows from successful Staples companies. And the fact that over three quarters of the 1973 universe has outperformed the market over getting on for 50 years I think does say something important about the fundamental strength and resilience of this industry.

How do Staples perform in inflationary regimes?

JF:  It’s been a while since we’ve seen inflationary times, but if we look back several decades we’ve got data for two 10-year periods when inflation was high or relatively high: the decades to December 1982 (when US CPI averaged 8.7%), and December 1992 (CPI average 3.8%).

I think the most important message is that earnings from the Global Staples[2] companies beat the market quite handily over both of those periods: annual growth in real terms of 4.2% in the first decade, compared to just 0.5% for the market, and 7.8% annually in real terms over the second decade, versus the market’s 2.6%. If anything, the advantage of high-ROIC, low capital-intensity businesses should become even more important in inflationary periods.

But a lot depends on the starting multiple, too. In December 1972 Staples started with a trailing P/E of 31.5 which went to 10.8 over the next 10 years, whereas the market only went from 21.8 to 11.7: that’s why Staples underperformed the market in the 1970s. Whereas over the subsequent decade both Staples and the market benefited to a similar degree from re-rating (Staples back up to a trailing P/E of 19.6; the market to 21.0).

Figure 2: Decomposition of annualised total returns

Figures show real and nominal returns in US$. Global Staples refers to an Ash Park Index calculated for the World Food, Beverages, Tobacco and Household & Personal Care sectors.

Source: Ash Park / Refinitiv Datastream

As things stand today, Global Staples and the market are both once again on a similar forward P/E, which puts Staples’ P/E Relative near a 20-year low and should mean the chances of de-rating driving underperformance are quite limited. Meanwhile it’s important to remember that on the measure which really drives long-term performance – the combined effects of earnings growth plus dividends – Staples has almost always beaten the broader market. That comes back to the consistency of delivery we talked about in the first post.

Figure 3: Combined returns from earnings growth and dividends, 10-year rolling

Nominal returns in US$. Global Staples refers to an Ash Park Index calculated for the World Food, Beverages, Tobacco and Household & Personal Care sectors.

Source: Ash Park / Refinitiv Datastream

What do you see as the biggest, most likely threats to a global staples portfolio.

JF:  On the macroeconomic side of things, weak global growth isn’t good – although we know that Staples does better than many other things in that scenario – and dollar strength also holds back returns because a lot of the large Staples companies are truly global, with big businesses in Europe, Japan, and emerging markets. A strong dollar (up nearly 30% on a trade-weighted basis in the last 10 years), along with very low inflation, help explain why Staples’ nominal returns over the last decade have been squeezed as shown in Figure 3.

There’s always the danger of self-inflicted harm if management chases short-term profit. That’s what drove the Schlitz example, and more recently you’ve seen something similar from the 3G businesses: an obsession with margins, and underinvestment in brands and growth, and that behaviour spread to other companies who got scared that if they didn’t boost their own margins they’d be at risk of 3G buying them. It was probably US Food – which we haven’t owned – that felt that effect most severely, and the good thing now is that most Staples companies are back in reinvestment mode, which should bode well for future growth.

The short-term approach is a bad idea anyway, but it’s even worse when smaller, innovative companies are trying to grab market share. And ‘disruption’ continues to be the threat that we find ourselves talking about most. Howard Marks had an interesting line in one of his recent letters: “the onslaught of startups with readily available capital and minimal barriers to scaling means that the durability of legacy businesses has never been more vulnerable or uncertain”.

That might well be true, but it’s something every sector is exposed to, and in the case of Staples brands it’s typically not like as a startup you’re creating a completely different technology: there might be things that are slightly different; maybe you can get the product sent straight to your door rather than having to schlep to the grocery store, but you’re really offering novelty. And if you’re not really offering something that revolutionary, what makes your new food or personal care brand any less disruptable than the legacy business whose lunch you’re trying to eat? You’re going to have to adapt, change, or be disrupted in future as well.

Ben Schott wrote a great Bloomberg Opinion piece a few months ago, gently sending up what he calls Blands: startup brands with slightly cutesy names and logos, like quip, Harry’s, GLEEM, Yumi and Bimble. They claim to be unique and groundbreaking but follow very similar formulas in terms of business model, look and feel, and tone, and they’re funded by large and successful VC and PE firms yet make themselves out to be the underdog.

The advantage incumbents have is that they have massive resource in terms of people, connections, distribution, marketing budgets, which they can put into adapting their own businesses. Some of them might be a bit slow, but they tend to get there in the end. Who’s going to deal with ongoing disruption better in the end: large, profitable companies or businesses which never made much margin in the first place?

Are we getting near ‘peak bland’? It’s almost exactly 10 years since Mike Dubin founded Dollar Shave Club, but allocators still tell us there’s a massive wave of capital making its way to new direct-to-consumer (DTC) brands. You’ve got more and more money chasing small consumer disruptors at higher and higher valuations. We want to stay clear of that. For the large companies this is sort of an outsourced R&D. They can watch the disruptors battle it out, see who emerges in this survival of the fittest contest, and then buy them and scale them up. This is something we watch carefully, and for the last couple of years we have been shifting our portfolio weightings out of megacaps and into some of the slightly smaller – but still sizeable – Staples companies which we can see have the right strategies and assets to thrive in this environment.

[1] Our first chart had 25 companies in it, but Carlsberg, Lindt, Pernod-Ricard and Smucker had market caps under $173m in January 1973.

[2] ‘Global Staples’ in this section refers to an index created by Ash Park using Refiniv Datastream data for the World Food, Beverages, Tobacco and Household and Personal Goods sectors.



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