October 20, 2017

Breakingviews: Consumer Goods Makers Poised For The Big Purge

by Breakingviews.

The 5 percent fall in Unilever’s share price on Thursday says something about the effect of hurricanes and bad weather on its third-quarter sales. It says even more about brittle valuations of consumer goods companies, which have been pumped up far above their long-term levels. The $180 billion Anglo-Dutch company’s wobble shows how that might change.

The 10 largest listed food, drink and household product makers, including Nestlé, Unilever, brewer Anheuser-Busch InBev and Procter & Gamble, trade at an average of 23 times the next 12 months’ forecast earnings – compared with a 10-year mean of 18 times. That’s largely because investors see them as being like bonds, with better returns. Operating profit margins, which average around 20 percent across the sector, haven’t really changed.

The rise in value isn’t new, but the generous monetary policy that sits behind it may be soon coming to an end. Consider what would happen were history to reassert itself. If that top 10 returned to their mean price-to-earnings multiple, some $346 billion of market capitalization would go up in smoke, according to Eikon data. Nestlé could fall $60 billion; P&G and Coca-Cola around $45 billion. Worse, the mortal world they would return to is more challenging than it has been in years. The number of consumers buying their first fridge has dwindled; the number with diabetes has rocketed.

Consumer groups are trying hard to recapture the spark by buying hipster brands, from “flexitarian” frozen meals to coffee stores. These, though, will take years to make any visible impact on earnings. Unilever and Nestlé are trying to restructure; Anheuser-Busch InBev has expanded by buying up rivals. Yet a miss on earnings or revenue has the potential to create an outsize impact on a company’s share price – and on those of its peers.

A squadron of activists targeting the sector might offer some support. Think Nelson Peltz at P&G and Daniel Loeb at Nestlé. But while valuations are high, shareholders don’t share the sense of urgency, particularly when small investors hold over one-third of the stock, as with P&G. Perhaps the one good thing about a purge would be that it gives activists a moment to shine.


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