Three outstanding consumer staple stocks

November 25, 2021 10:24

Livewire Markets

The contrasting worlds of cryptocurrencies (red-hot and risky) and consumer staples (lagging in the wake of the pandemic) are preoccupations of the Alphinity team at present, says its global portfolio manager, Jeff Thomson.

In this episode of Expert Insights, Thomson tells us how his team are cutting through the noise to understand the opportunities and risks of crypto.

"We don't have a view on what Bitcoin is worth," he says. Instead Alphinity are thinking about the underlying technology and the regulatory implications.

"Once everyone knows the rules of the game, I think ultimately you're going to see very significant investment. I think it's going to become mainstream very, very quickly."

He also discusses the opportunities in consumer staples and the importance of analysing pricing power.

Thomson gives two examples of consumer staples — L'Oréal and Estée Lauder — that can do no wrong. They were doing well before and during COVID, and are now cleaning up during the reopening. They have even benefited from the shift to e-commerce.

His third example, Nestlé, is another veteran that refuses to sit still, and has pricing power in multiple high-growth categories.

Edited transcript

How do you see cryptocurrency playing out with the big financial institutions in the next year?

This is an area we are focused on and I think you ignore it at your peril. The stakes are exceptionally high.

This is a compelling technology, the blockchain technology that underlies it, but also the non-fungible tokens, the digital currencies that the central banks are likely to launch in the near term. This is huge.

I mean, we don't have a view on what Bitcoin is worth. We are slightly cautious and there's a speculative element there that makes us somewhat cautious.

But what we are focused on is that underlying technology. And I guess the answer with banks, and it's something we are thinking about quite deeply, is to what extent is this a threat to the traditional banking system?

I think the answer there is yes, it is a threat, but it's also an opportunity. One of the key aspects we're looking at is how banks are approaching it.

The real hurdle though for crypto, I think, is really resolving that public policy element. What are the regulatory ground rules?

I think everyone is really waiting for that. And I know that probably presents a near-term threat for some of these assets, but we think ultimately that's going to be very, very positive.

It's going to mean that once everyone knows the rules of the game, I think ultimately you're going to see very significant investment.

I think it's going to become mainstream very, very quickly. Having said that, it's already starting to impact some of our companies.

If you had to choose, which area of cryptocurrency would you focus on?

Gosh, I think all of them in their own right are interesting. For a financial analyst, clearly there's two parts that I'm most focused on.

One is the payment platforms. I think to the extent that crypto can disintermediate the traditional payment systems and to the extent that banks are involved and generating revenues, that is clearly a threat. But I guess ultimately it's going to be determined by the consumer.

What is the value proposition for a consumer? The fact that it's cheaper or you're not paying an interchange fee isn't really interesting for me as a consumer. I just want a secure transaction.

And I think the traditional payment system, for all its ills, does offer a lot of consumer-friendly aspects. So, if you pay with a Visa or MasterCard, for example, you can get charge-back facilities, there's fraud protection, et cetera.

Instant payment is not always good when you can't get your money back. But again, that'd be one area. The other one is decentralised finance — the defi option — where you can actually get a loan or insurance product and completely bypass the traditional banking market.

And that clearly would be a direct threat to the banking system. But again, I think there's a huge amount of risk here to the extent that if it starts to undermine credit distribution within the economy through the traditional system, I think regulators will be very sensitive to that.

Why are you looking closely at consumer staples right now?

Consumer staples is a focus sector for us at the moment because it is actually lagging.

There's probably two key things that you need to understand when you're looking at staples at the moment. They both, you could argue, are related to the impact of COVID and normalisation post-COVID.

The first is, I guess, the normalisation of the top line. To the extent that we all went home and hibernated in lockdowns and ate too much and pantry-loaded and bought a lot of toilet paper, et cetera — and chocolates — obviously that was a good time for these companies.

They probably oversold, or they're definitely oversold, and there's a normalisation. I think the market's trying to understand what that looks like at the moment.

We know the comps are very tough and we're still working through that, but the outlook is relatively unclear. The second is, again, related to COVID, is really these cost pressures.

Obviously we're in a very inflationary environment — there's logistics issues, there's labour inflation, commodity inflation — and it's a wide and diverse sector, but generally speaking, these companies have not been great at passing on prices and costs.

So the one I'd call out is, again, food manufacturing, where historically this has not been a happy environment for them.

There's probably one area of consumer staples that we do like, which is the cosmetic companies. So L'Oréal (XPAR: OR) and Estée Lauder (NASDAQ: EL). We like both of them.

At the moment we own Estée Lauder, but I think the primary driver there is really the premium skincare market.

It's one of the few categories in consumer staples that is really growing year on year, and underpinned by that emerging middle class, in Asia more broadly, emerging markets more broadly, but particularly in China. It's a phenomenal story.

Then you've got the travel retail channel, which is in the process of opening up. The added leg is cosmetics and fragrances, which are really driven by social occasions. As we go back to work, go back to restaurants, go back to nightclubs, people start buying fragrances again, and cosmetics.

Then there's also an interesting dynamic in terms of e-commerce. This is one of the few categories which was winning before COVID, won through COVID because people sat at home and ordered things online, and is now winning after COVID.

If anything, it has been able to power through and it's been a really phenomenal growth story.

Nestlé (SIX: NESN) is probably the one stock we would call out which we think does have some degree of pricing power. Perhaps not as much as the cosmetic companies, but certainly, we feel, can manage that margin pressure very well.

That's mainly because they are now in high-growth categories — primarily coffee, premium pet care, nutrition. They've got a phenomenal licence agreement to Starbucks, which is going very, very well. That's one company we do own and we are positive about.