Standard Life Investments

Through the Lens

Big brands - the end of an era?

  • The era of predictable profits from branded consumer goods is coming to an end
  • Barriers to entry have fallen due to low cost advertising and high quality contract manufacturing
  • Investors need to find companies that are either adapting or operating in profitable niches

Branded consumer goods such as Colgate toothpaste, Heinz baked beans and Nestlé chocolate have been a favoured investment theme for many investors. In particular, producers of consumer staples have been profitable, predictable businesses. They have offered compelling dividend yields and top-line growth, especially those companies with a meaningful exposure to emerging markets.

Falling bond yields over the last three decades have also helped. Many consumer staples companies have been ‘bond proxies’, offering relatively safe, reliable returns and higher yields than the bond market. This has created a perception of capital protection. However, a number of fundamental changes mean new entrants are challenging this perception.

Fading advantages

Big branded consumer goods companies owe their strong market position to historical advantages over the competition, but these benefits are starting to erode.

In the past, they had the financial muscle to advertise on national media and build brand recognition in a way smaller companies could not. Now, social media platforms allow companies to generate brand awareness by targeting specific niche audiences on a far smaller marketing budget.

Formerly, big brand companies had a strong manufacturing advantage. Now companies can compete on design and marketing while outsourcing all or part of the manufacturing to third-party contract manufacturers. They can produce goods that rival the quality of the big brands, from clothing to detergents to cosmetics. This has also benefited discounters with strong ‘private label’ brands (see chart).

Once, big brand companies had strong relationships with retailers, allowing them to dominate shelf space. Nowadays, new entrants can ship direct to the consumer, using platforms like Amazon or China’s Tmall. In addition, retailers are directly competing with their own private label products.

In the US shavers market, where Gillette has dominated for years, new entrants like Harry’s Razors and Dollar Shave Club have gained 20% market share in four years. This prompted Unilever, an incumbent big brand company, to acquire Dollar Shave Club for $1 billion.

In Europe, private label food products now exceed 40% of sales in large markets such as Germany, the UK and Spain, and continue to grow rapidly at the expense of traditional established food brands. In popular discounter supermarkets, such as Aldi and Lidl, that percentage is even higher. The US has been late to adopt this trend and only about 17% of nationwide sales are private label. However, leading retailers such as Costco are pushing this number higher.

Big brands forced to adapt

This change is now affecting the economics of big brand companies, with firms like Nestle and Reckitt Benckiser accepting that their growth is more challenged. To protect profitability, some are cutting expenditure on advertising and promotion. This move led to a series of disappointing results from ad agencies and TV broadcasters, the channels that once helped build those mega‐brands.

This approach may be counter‐productive. Stopping advertising activity can provide short‐term cost savings, but may undermine the value of the brand in the long term.

Risks and opportunities for stock‐pickers

What does this mean for the global stock‐picker? For one thing, the reliability of the big brands’ revenues can no longer be taken as a given. Moreover, valuation multiples are historically high, suggesting that investors do not fully appreciate these risks.

However, there are also opportunities. Some consumer staples companies were early to adjust. Kraft Heinz – a product of the merger between Kraft and Heinz, with backing from 3G Capital and Warren Buffet – was one of the first to introduce zero‐based budgeting for lower‐growth products, which allows strategy to quickly adapt to the new reality.

Growth continues in categories like functional and performance nutrition, thanks to health trends. Mead Johnson, a leading manufacturer of infant nutrition, was acquired by Reckitt Benckiser for $18 billion in June 2017. Among smaller companies, an example in this sector is Glanbia, an Irish‐listed manufacturer of protein sports nutrition products, which is building a leading – if niche – brand.

As always, understanding the implications of material industry change and finding companies that benefit from that change are key to successful stock picking.