Two Picks in the Household and Personal Care Space
We believe the market's fears regarding these investment ideas are overblown.
Consumer behavior is changing rapidly in the face of the current global economic slowdown. This phenomenon is not only affecting discretionary spending--like buying a new car or traveling--but it is even affecting consumers' purchases of everyday staples like household and personal care (HHPC) products. While the game is definitely changing, we've accounted for this in our valuations and contend that there is still value in a few names.
In this article, we'll take a brief look at the changing landscape of the HHPC industry and review the top two picks that we think are cheap enough to invest in.
Consumer Trade-up Is a Thing of the Past
Over the past 10 years, HHPC firms have repositioned their product portfolios toward higher-priced products where consumers have demonstrated a willingness to pay a premium (such as skin care, hair care, cosmetics, and natural and organic offerings). These efforts to entice consumers to trade up to more premium offerings have been a successful strategy to realize higher gross margins--that is, until recently. In this environment, where unemployment continues to rise, saving money is winning out relative to spending dollars on nonessential items. For instance, consumers may not be as willing to pay up for diaper swim pants or sophisticated razors in this more difficult economic period as they were just a year ago. As a result, we believe that trading consumers up to higher-priced offerings will likely take a back seat to brand retention over the next several years, as it is cheaper to keep an existing customer, even one that is highly incentivized through promotions, than to reacquire that same individual later when the economy improves.
Consumers are Utilizing Multiple Tactics in Order to Save Money
In an effort to rein in their spending, cash-strapped consumers are changing their shopping behaviors. For one, consumers are increasingly opting for lower-priced private-label (nonbranded and store-branded) alternatives or value-branded goods, as shown in the chart below. According to IRI, private-label products cost 30% less (on average) than branded products. This price gap increases to as much as 64% for beauty care products, but beauty care has not been as susceptible to consumer trade-down because the research and development investments that go into beauty care products are less easily imitated by private-label offerings.
Even if consumers aren't opting for private-label alternatives in certain segments of the HHPC space, some categories are vulnerable to consumer trade-down within categories or brands. More specifically, consumers have shown a willingness to trade down from department store beauty care purchases to mass market offerings. For instance, Procter & Gamble's (PG) new Olay Pro-X (the firm's highest-end skin cream) is priced at $50--a top-end price point for a mass market stock-keeping unit (SKU) but lower than department store offerings--and it has been a huge success, achieving 5% all-outlet value share (excluding Wal Mart (WMT)) in its first three months on the market.
But the money-saving tactics for today's value-conscious consumers don't end there. Consumers are occasionally trading out and being more discriminating about their household purchases, with some categories clearly proving more resilient than others. For instance, consumers may not be buying the newest fragrance that just hit the shelves but they may still buy their favorite foundation when they run out. In addition, consumers are making their products last longer by using a smaller amount and using up what they have in their pantries before they hit the store to replenish their supply. To keep a tighter rein on their purse strings, consumers are also making out their shopping lists ahead of time to minimize unplanned purchases and shifting their shopping trips to discount channels.
HHPC Firms are Not Just Sitting Still
Obviously, consumers are looking for value wherever they can find it, and HHPC firms have taken note. For example, some HHPC firms have adjusted their advertising message to tout the value proposition they believe their products offer consumers, while others have increasing used promotions to resonate the value of their offerings with consumers. More specifically, in the beauty care space, gift-with-purchase promotional programs continue to benefit some larger players, like L'Oreal and Estee Lauder (EL). Beyond these efforts, adapting the product size is also a standard coping strategy for HHPC firms.
Despite this focus on value, we don't believe that big price rollbacks are likely. Over the past few years, companies in this sector have been facing unprecedented input cost inflation. Although HHPC firms have passed through prices increases to offset a portion of this cost pressure, these price hikes have not fully captured the costs these firms have had to absorb. Kimberly-Clark (KMB), for instance, has only recouped half of the $2 billion in cost inflation it realized over the past five years through higher prices. Similarly, P&G pushed through a price increase on its Tide detergents, but the increase only reset the retail price to 2004 levels, as shifts to bulk purchases and club channels drove down the retail price per use over this time. Even though we believe that large price cuts are unlikely, if the price gap with private label becomes too large, branded firms may be forced to cut prices or risk substantial volume declines.
Moreover, if consumers are becoming more selective about their purchases, we don't believe that this is the right time to introduce new products--and HHPC firms seem to agree. With the macroeconomic environment is as choppy as it has been, companies are favoring a reliable stream of more modest innovations and less risky brand line extensions.
Value Remains in the HHPC Space
Without a doubt, HHPC firms face a broad array of challenges, but we take comfort in the fact that the firms we like in the HHPC space have successfully navigated through recessionary periods in the past. While the HHPC sector likely won't generate eye-popping returns, we think the market has unfairly punished some of these companies, giving investors with a long-term horizon a chance to buy solid firms that can withstand the test of time. Although we have fewer 5-star stocks in our coverage universe following the market's recent runup, we've provided our top two picks in the household and personal care space below. To see our full Analyst Research Reports, fair value estimates, and uncertainty and moat ratings on these and more than 1,900 other stocks, take a free Premium Membership trial today.
Procter & Gamble (PG)
Uncertainty Rating: Low | Price/Fair Value Estimate: 0.69 | 5 stars
In our opinion, at just 13 times forward earnings, the market is overly discounting P&G's shares due to the numerous head winds that the firm faces (namely, soft consumer spending, unfavorable foreign currency rates, and elevated input costs). That said, we strongly believe that P&G knows the consumer, and with brand offerings that span the spectrum from value-priced to more premium-priced, we think the firm is well-positioned to hold market share in its categories. The company has also learned its lessons from previous downturns when it wasn't as defensive on market share and dialed back on new product innovation. We don't expect it will make the same mistakes again. Moreover, we believe that P&G has opportunity to improve productivity and reduce costs--a message that came through at the CAGNY conference, which we attended earlier this year--as well as generate outsized sales growth in emerging markets where it is still underpenetrated. We expect these factors to lead to higher earnings and, thus, a higher stock price in the future.
Uncertainty Rating: Medium | Price/Fair Value Estimate: 0.62 | 5 stars
Over the past year, Energizer shares tanked on unfavorable foreign currency exposure, concerns about battery destocking at U.S. retailers, and fears that the company's portfolio is less attractive in the current market. While there is some merit to these concerns, we don't believe they warrant the discount that the market is demanding, with shares trading at just 9 times forward earnings. Numerous acquisitions over the past five years have been designed to further diversify Energizer away from its commoditylike battery business. Many of its brands, including newly acquired shaving brands, skew to more of a value propositioning, which should serve the firm well in the current economic environment. In addition, the firm has done a solid job of building its brands and capitalizing on its acquisitions over the long run. Further, although the payback for one of its acquisitions, Playtex, is taking longer to realize that was initially expected, we still see opportunities for margin expansion, which should support a higher price over the longer term.
Erin Lash does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.