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Consumer staples: Should they be portfolio staples?

Everyone is familiar with consumer staples – e.g. groceries, beverages, home and personal care items – and many have a strong affinity for the underlying brands, with some brands having dominated their markets for generations (around half the world’s population use Unilever’s products daily). However, the consumer staples sector is often considered to be one of the sleepiest in the stock market. Kamal Govan investigates whether there is any opportunity to awaken investor interest. 

As the adage goes, a good business is not necessarily a good investment. The global consumer staples sector has underperformed the market, represented by the MSCI World Index, over 10 years, as shown in Graph 1. In fact, the performance of many consumer staple stocks has been disappointing over most time periods since the turn of the millennium (see Table 1). Are these companies fundamentally broken, or are there opportunities for contrarian investors? 

Graph 1- MSCI World Consumer Staples Index.png

Table 1- US$ total return of select indices and consumer staple stocks.png

Characteristics of consumer staple businesses

Investors typically seek out consumer staple stocks because they are considered to be defensive. Some of the important characteristics that underpin this belief are: 

Stable volumes and pricing translate into steady topline growth.

Relative to the average business, defensive businesses have more consistent earnings streams, which enable them to consistently reward shareholders with dividends. Not only that, but defensive businesses can also support higher debt loads through business cycles. This creates significant option value during difficult economic times. 

Of course, all industries face risks and, for consumer staples, some of the noteworthy risks include: 

Shelter from the storm

Consumer staples have historically provided investors with shelter during economic storms. Graph 2, a historical expansion of Graph 1, displays the significant and often-rapid outperformance of consumer staples during periods of significant economic stress.  

Graph 2- MSCI World Consumer Staples Index relative to MSCI World Index.png

A deeper look at the period around the dotcom crash provides an example of how these stocks perform under economic stress (see Graph 3). Consumer staples and other defensive sectors, such as utilities, telecoms, healthcare and technology, underperformed in the build-up to the dotcom peak on 27 March 2000, however, these same sectors witnessed massive outperformance when the bubble burst. 

Graph 3- MSCI World Index and sector-specific indices.png

Another consideration when investing in consumer staple stocks is where we are in the interest rate cycle. The sector is often seen as a stock market proxy for bonds due to the high, stable dividend yields of the underlying companies. In times of high interest rates, investors can substitute consumer staple stocks for fixed income investments. Conversely, in times of low interest rates, more value is attached to their dividend yields. It is perhaps fair to say that the current direction of travel for interest rates is lower.

Consumer staples have historically provided investors with shelter during economic storms.

Not all consumer staple businesses are created equal

Having made some arguments for owning consumer staples, the next question is why we own the ones we do. Long-time readers will appreciate that we do not select stocks based on overarching macroeconomic views. We are fundamental, bottom-up investors; we invest in companies we believe are undervalued and sell them when they reach our estimate of their true worth. Having said that, there are certain commonalities that we can draw from the consumer staples exposure in our portfolio. Broadly speaking: 

Selected investment case snippets

The Allan Gray Balanced Fund has about 14% exposure to consumer staples when factoring in both domestic and offshore stocks. British American Tobacco and Anheuser-Busch InBev (AB InBev) together make up just over 8% of this, while the remainder is diversified both locally (e.g. Tiger Brands, AVI Limited, Premier Group) and offshore (e.g. Asahi Group, Unilever, Diageo). Below, we highlight some of the aspects that add to their investment cases. 

… we believe that our selection of consumer staple stocks provides us with a good combination of downside protection and sufficient self-help levers to improve their respective expected returns.

In summary, we believe that our selection of consumer staple stocks provides us with a good combination of downside protection and sufficient self-help levers to improve their respective expected returns. 

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