COVID-19 and Consumer Behavior: Investment Considerations
Tanya Stavreva, CFA Senior Vice President, Portfolio Manager
David S. Lynch, CFA Cheif Investment Officer
Around the world, the pandemic has pushed consumers toward “pantry stocking”, which has pulled forward demand for staple products. However, the initial surge in food, cleaning products, and toilet paper might not be sustained and will impact investment opportunities in this sector differently over the short-, medium-, and long-term. Similarly, consumer behavior will likely be permanently changed in many ways or, at least, very slow to return to former habits.
Grocery store sales growth remains at eleveated levels, after the early pantry load spike in late March as consumers restock
The pandemic is creating more unemployment, economic recession, and less financial security for many consumers. This will result in less discretionary spending and a retrenchment into simple essentials and cheaper products. Consumers are expected to trade down in brand and spend less on premium products. The trend for fresh and healthy foods commanding a higher profit margin for sellers will likely take a hit due to the higher costs and faster perishing of these foods. Frozen, canned, and pantry-stable foods will be a beneficiary of the current climate. People still need to eat, of course, but food sold to grocery stores has a lower profit margin than food sold to restaurants. Similarly, some of the trend toward natural, premium cleaning products will likely be stunted back toward traditional brand names.
Globally diverse companies with strong sourcing and distribution networks that can ramp capacity and get product to market to address shortages will be well-positioned. Do you really care what brand your toilet paper is right now, just so long as you can get it? Also, those companies that can execute and pivot distribution to new points of sale to replace the loss of cafeterias, college campuses, sporting venues, restaurants, and caterers will be better able to survive the pandemic disruption. However, companies that were not reliant on these channels prior to the pandemic are even better positioned to thrive and take further market share.
While the short-term surge in grocery sales and pantry stocking is a boon to many companies, it is not a guarantee that these volumes will be sustained. Perishable foods will be consumed and need to be replaced, but things like toilet paper, canned foods, and cleaning products could eventually be an inventory backlog that consumers have to work down for some time into the future before needing to re-stock, particularly after the pandemic finally eases.
A proprietary survey done by investment research firm Stifel last week, suggests that consumer spending intentions are starting to moderate from the peaks seen in March and April. Although while pantry loading may have peaked, overall household purchases of consumer staples remain at double the levels of early March as stay-at-home dining continues to drive robust demand for groceries. However, as restrictions ease, these elevated levels are also likely to revert closer to their long-term averages.
From an investment perspective, a short-term spike in sales volume and growing revenue does not automatically equate to major profits. There are mixed dynamics to be considered when assessing future profitability. For example, diesel fuel for shipping and distribution is getting cheaper, but safety precautions, store reconfigurations, hiring needs, pay raises, and enhanced sick leave policies are a growing cost. In addition, plants, factories, and stores working at reduced capacity due to social distancing, are less able to absorb significant fixed costs as per unit production cost increases. As highlighted on the news, this is not just a challenge for consumer-facing companies like Walmart but is particularly dire right now in the meat packaging industry, with impacts all the way through the food supply chain.
Some staples companies are better positioned than others, as coming out of COVID-19, we are likely to see stepped-up hygiene and sanitation protocols across consumer, commercial, and institutional locations. However, the volume surge that we saw in March and April in food is unlikely to be sustained particularly as lockdowns ease and constraints are lifted. There are additional excellent investment opportunities beyond the consumer staples companies themselves. For example, virus and germ fears are quickly pushing the world to even more touchless, cashless transactions, which bodes well for credit card companies and providers of payment technology. Also, delivery demand creates investment opportunity with shipping and logistics providers.
We are nearly through quarterly earnings season and the beginnings of these trends are showing up in company financials. Future earnings guidance from companies is severely limited, but the trends above are all factored into our models and portfolio positioning as the pandemic evolves.
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