How would you describe the Consumer Staples sector and its place in a portfolio?
Consumer staples are often a healthy portion of portfolios because they offset the higher volatility sectors. These stocks are definitely valued in legacy accounts where there is a relatively conservative investor or where a high dividend is preferred. And at times, those accounts can even have an over-allocation to consumer staples. When it comes to the stocks themselves, there is a fairly wide range, but generally, they are defined by products that consumers purchase continually. These are products that aren’t bought on a discretionary basis but are recurring and often necessary for most households. Examples would be toilet paper, coca-cola, bottled water, and cleaning supplies. Interestingly enough, Wal-Mart is classified as a consumer staple stock. Although it should be considered more of a retailer, it certainly provides many of these staple products to its customers. Some more segment examples would be beer, liquor, and cigarette companies.
How has the COVID-19 pandemic impacted the consumer staples sector?
In general, a lot of the consumer staples stocks were helped by COVID-19. Pantry loading certainly helped companies like Procter & Gamble, and even the cigarette companies did a lot better than expected. There was speculation that people sitting inside all day might limit smoking, but people consumed a lot of cigarettes during quarantine. The same thing with beer, as alcohol consumption was relatively high. Beer on-premise, meaning beer served at a restaurant, was obviously quite low, but consumption at home was high. A great example of this is Constellation Brands, the company behind brands like Modelo and Corona. They performed quite well in this environment, as 85% of Corona sales are actually off-premise, and they sold a significant amount of Corona during this time. Proctor & Gamble and Kimberly-Clark experienced heavy pantry loading, especially with products such as toilet paper and paper towels. The attention now turns to the next six to nine months. With pantry loading having already occurred, will consumers have to work through their existing product, or are they going back to the store?
How much of the Corona beer sales growth was due to people drinking it as a meme?
I think it was a huge part of it. That’s all I drank during coronavirus. Lime sales were up, and Corona sales were up. Overall I think they performed quite well despite negative expectations. It was an understandable concern leading into the pandemic that consumers would avoid the Corona brand due to its connection with the virus. Ultimately, they had more issues with getting Corona to stores, as the manufacturing facilities shut down in Mexico, leading to supply chain issues. So the demand was certainly there, the supply side was the only issue.
So, it sounds like consumer staples did their job during the pandemic.
It generally did, but I think one of the weaknesses in consumer staples is that there’s a temptation for leveraging. This is where some of the staples’ benefit actually works against them. For example, in the beer industry, you have companies that have only grown by consolidation. Names such as Anheuser-Busch and Molson Coors have very high leverage ratios because they have consolidated so many of the smaller beer manufacturers. Over time, the beer industry has not performed very well, especially in those legacy beers. The craft beers had been doing better, and the beers with a little extra branding like Corona had been doing better. Anheuser-Busch and Molson Coors are stuck with these massive debt loads, but they don’t have the corresponding sales growth to escape the debt. Their temptation is to think that they can grow horizontally, create a monopoly, and build pricing power. However, if you don’t get it right and start growing sales, you’re stuck with a high debt level and a low sales base. When a market disruption like COVID occurs, that extended leverage immediately paints a target on your back, and the hedge fund hawks start betting that a default will happen. While these higher levered companies performed poorly in the last months, with Anheuser-Busch and Molson Coors both down quite a bit, other companies with lower debt loads certainly performed better.
Who were some of the winners coming out of the last few months?
It’s difficult to find big winners in consumer staples. I really think that consumer staples are defined by marketing skill, and that’s difficult to delineate. In the Narwhal perspective, we look through the three lenses of the company’s moat, management, and macro-environment. With consumer staples, the macro is just plain flat. There might be some segments that trend up or down, with cigarettes being the best example of a constant downtrend. Generally, though, you’ll see -1% to +3% year in year out. The differentiator is the level of marketing skill. And then you have other factors such as timing. For example, Clorox was in the right place at the right time this year. They’ve made good decisions with new products like Clorox wipes, but they ultimately just nailed the timing. People needed cleaning products, and Clorox was the beneficiary. It’s certainly possible to generate differentiated returns in this sector, but typically consumer staples aren’t going to provide tremendous alpha.
How does Narwhal think about allocating client portfolios within consumer staples? Are we typically underweight or overweight?
As a firm, we tend to be overweight consumer staples. It helps to provide a little bit of ballast in down markets, and they also tend to tick a lot of boxes that we like to see. We seek companies with strong management teams and good market positioning, and consumer staples often provide those. We also look for a macro-environment that isn’t hyper cyclical and doesn’t require perfect entry or exit timing. Consumer staples fits the bill with stability, and that’s why we end up being a little overweight these companies.
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