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Will China Concerns Weigh on Consumer Staples Companies?

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Global growth worries have been haunting the markets lately, primarily stemming from the uncertainty in China and other emerging economies. The Chinese central bank’s move to cut interest rate and devalue its currency in August to prop up growth also failed to calm investors. In fact, investors’ fears were heightened after the continual stock market losses in the last week of August. Moreover, the growing concern over the health of the Chinese economy started impacting global markets, be it in the Asian, European or the U.S. markets.

The recent soft September non-farm payroll report and negative revisions to the prior two months indicates that the U.S. economy may not be as immune from global cross currents as many have been hoping. Other measures of economic activity, particularly the two ISM surveys, in addition to trade data and inventory build out suggest that GDP growth in Q3 decelerated markedly from the preceding quarter’s fast pace.

Amid a derailed Chinese economy and global issues, the U.S. Federal Reserve also decided to delay its first rate hike. Though the Fed’s decision brought a sense of relief, it also cast a shadow over the timing of the first interest rate increase. While, a number of Fed officials have indicated that it might arrive at the one of the two remaining FOMC meetings this year, but other experts feel that weak job figures along with low inflation in U.S. are likely to delay the hike in Fed interest rates into 2016.

This uncertainty over interest rate hike and global concerns will thus continue to put pressure on consumer staple stocks in the third quarter and full year results.

We also note that consumer spending pattern is changing and consumers are not willing to spend despite benefiting from lower fuel prices and higher wages. While some are busy boosting their savings, some are burdened with higher health care costs and still-tightened credit availability.

In fact, there are many consumer staple stocks, which are still suffering from continued pressure in the face of limited consumer spending, foreign exchange headwinds and declining unit volumes. Other global issues including potential price wars, a competitive environment, political turmoil in Russia, sluggishness in Japan, and struggle in Europe continue to hinder the financial health of these companies.

Hence, investors should be careful while investing in consumers staple stocks in the near term. Given below are certain headwinds that are likely to prevail in the coming months.

WEAKNESSES

Slowdown in Emerging Markets


The majority of the global population lives in emerging economies. Due to a slowdown in income and consumption growth, affordability goes down. Though there remains huge opportunity for sales growth in these markets, currently the state of affairs remains volatile. Developing countries like China, Brazil and Mexico are facing economic slowdown. The Middle East, Russia and Ukraine are witnessing continued political and civil unrest resulting in challenging operating conditions. Some developed markets are also facing weakness due to sluggish consumer demand.

For example, consumer product company, Unilever plc (UL - Free Report) witnessed some improvement in India and more stable conditions in China in the first half of 2015, but is still struggling with declining volumes in Brazil and a soft economy in Russia. The company is also witnessing weakness in the developed markets with little sign of recovery in North America or Europe. Moreover, it still remains cautious as consumer demand continues to be weak.

Beverage giant The Coca-Cola Company (KO - Free Report) also remains apprehensive of broader economic challenges in the future quarters. While the macro-environment is improving in the U.S., Coca-Cola expects challenges in many key emerging/developing markets like Brazil, Russia and China.

Ongoing economic softness and operating challenges in Europe, evolving consumer landscape and an increasingly competitive environment have also been hurting Coca-Cola Enterprises, Inc.’s (CCE) top line. Management expects these challenges to persist in future quarters, which, coupled with increasingly strong currency headwinds, will limit revenue growth.

Companies like Procter & Gamble Co. (PG - Free Report) and Kellogg Co. (K - Free Report) are also struggling with decelerating growth in the developing markets and currency headwinds. U.K.-based brewer, Diageo Plc (DEO) also faces macroeconomic headwinds and tough retail conditions in emerging markets.

Unfavorable Foreign Currency Impact

Companies which have a significant presence in the emerging markets are being affected by currency headwinds, given the recent weakening of many emerging market currencies against the U.S. dollar. In particular, the recent currency fluctuations in Venezuela, Argentina and Turkey are a major concern.

Foreign exchange is a major headwind for companies like Estee Lauder Companies, Inc. (EL), Mondelez International, Inc. (MDLZ - Free Report) , General Mills, Inc. (GIS), Kimberly-Clark Corp. (KMB - Free Report) , Unilever, PepsiCo Inc. (PEP - Free Report) , which have significant business outside the U.S. Venezuelan currency issues are also hurting Nu Skin Enterprises, Inc.’s (NUS - Free Report) earnings significantly.

Declining Volumes

Many consumer staple companies are struggling with declining volume or soft volume growth, which is hurting their top-line.

For example, tobacco companies like Altria Group, Inc. (MO - Free Report) , Philip Morris International, Inc. (PM - Free Report) and Reynolds American, Inc. (RAI) are facing declining shipment volumes mainly due to higher prices of cigarettes. The government has imposed higher excise taxes on cigarettes, as a result of which tobacco companies are increasing their cigarette prices. Higher prices of cigarettes are leading to lower cigarette volumes. Further, selling of fake versions of the top-branded cigarettes by local retailers are also hurting the cigarette volumes.

Global brewer Molson Coors Brewing Co. (TAP - Free Report) has been witnessing negative beer volumes in the U.S. and Canada for quite some time. In the U.S., the volume declines can be partially attributed to relatively weak economic conditions. In Canada, the premium beer segment has been losing volume since 2001 to the above premium and value segments, mainly due to an aging population and sluggish economy.

The loss of the Modelo brands in Canada due to the termination of the joint venture at the end of Feb 2014 will also lead to volume declines in the near term.

Volumes of food company Mondelez International have been dismal in 2014 and so far in 2015 due to significant pricing actions in response to commodity cost increases, intense competitive pressure, slow response by competitors to higher input costs and the impact of pricing related disputes with retailer customers.

Beverage companies like Dr Pepper Snapple Group Inc. (DPS), Coca-Cola and PepsiCo have also been continuously posting sluggish results in their domestic beverage businesses due to category weakness. Muted volume trend will remain a continuing concern going forward.

Bottom Line

As is evident, there are plenty of concerns in the consumer staples industry. However, as regards investing in the space right now, are there any opportunities for short-term investors?

Check out our latest Consumer Staples Outlook here for more on the current state of affairs in this market from an earnings perspective and the trend in this important sector of the economy.

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