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Back to basics

Emerging markets are a potential boon for stocks in the consumer staples sector.

  • By Robert Lee, Portfolio Manager,
  • Asset Management
  • – 10/23/2013
  • Consumer Staples Sector
  • Investing in Stocks
  • Consumer Staples Sector
  • Stocks
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Many multinational consumer staples companies that produce and sell products such as shampoo, bottled water, and toothpaste in emerging-market countries have seen a deceleration in the rate of year-over-year sales growth so far in 2013. However, this rate of growth in emerging markets still remains strong, particularly relative to levels seen in mature, developed countries.

This deceleration in sales growth of consumer products in emerging markets follows a trend largely in place since 2011, which was the most recent peak in the sales growth rate for both emerging market and developed countries since the 2008–09 global financial crisis. More specifically, year-over-year sales growth in emerging-market countries for a basket of multinational consumer staples companies declined to 6.0% at the end of June 2013, from 7.4% at the end of 2012, and down from the peak of 11.8% at the end of the third quarter in 2011. Comparatively, sales growth in developed countries was flat at the end of the second quarter of this year, down from 1.7% at the end of 2012 and from 2.5% at the end of 2011 (see the chart below, right).

State of the consumer staples sector

These stocks generally appear slightly cheaper than the broader U.S. market.
Read the article.

This deceleration has contributed to the sector’s low single-digit rate of earnings growth during 2013. The primary driver for the slowdown in the pace of sales and earnings growth in emerging-markets during the first half of this year has been economic deceleration, particularly in countries such as China, Brazil, and India.

The law of large numbers has also been a factor.1 During the past decade, many staples companies have been aggressively expanding their distribution in emerging markets to reach many consumers for the first time. When a product first becomes available in a new city or a new retail channel, the rate of growth in the first few years can be abnormally high because the base level of sales is so small. As the product becomes more established, the base level of sales becomes much larger, so each incremental consumer will have a much smaller impact on the growth rate. This deceleration isn’t necessarily a sign that the product is not successful; it is simply a reflection that growth rates naturally diminish as a product’s sales base gets larger.

Investment implications

Despite the inevitable deceleration in sales growth for many staples manufacturers, the good news is that the sales growth rates in emerging-market countries remain strong relative to the business conditions in developed countries, and can continue to be a key driver in the sector going forward.

Taking a longer-term perspective, the per-capita consumption of consumer staples items in many emerging markets is still substantially lower than it is in the average developed country. This is because consumer incomes and retail distribution are still underdeveloped. As consumers’ purchasing power continues to rise in these countries, and as staples companies further increase their manufacturing and distribution capabilities, it would be reasonable to expect that sales growth rates would continue to exceed those in more mature markets, where staples products are widely available and consumed.

Looking at various categories within the sector, some products tend to penetrate emerging markets more quickly than others. For example, food manufacturers can face the challenges of various localized taste preferences in different markets. What is popular to eat for breakfast or as a snack in China may be quite different than what is generally preferred in the U.S. By comparison, consumers tend to have more similar or universal preferences when it comes to such staples items as soft drinks, bottled water, toothpaste, shampoo, and diapers.

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Past performance is no guarantee of future results.
Because of their narrow focus, investments in a single sector tend to be more volatile than investments that diversify across many sectors and companies.
The consumer staples industries can be significantly affected by demographic and product trends, competitive pricing, food fads, marketing campaigns, environmental factors, governmental regulation, the performance of the overall economy, interest rates, and consumer confidence.
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1. Law of large numbers: A theorem in probability theory that suggests that as the number of samples increase, the average of those samples is likely to reach the mean of the whole population. In the context of this article, as a company grows in a certain market, its chances of sustaining the same large percentage of growth diminish.
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