Consumer packaged goods companies (CPG) typically referred to as “consumer staples” are universally considered to be safer investments within the equities complex. What isn’t safe about toothpaste, batteries, laundry detergent, and sliced cheese? Regardless of the economic environment, our consumption of these day-to-day items doesn’t change much. But wait, here is the best part. They are far from boring. Consumer Staples have produced the best returns vs. other sectors over the past 50 years, with the second-lowest volatility (Utilities have the lowest volatility). Talk about having your cake and eating it too! A generation of investors has relied on the steady cash flow and dividend growth produced by these companies. This brings us to the obvious question, “will the trend continue, does the bunny still have juice?” Before we try to figure out the future, let’s first examine the past.
Over decades, CPG companies have grown by leveraging two wide moats: 1) a distribution moat, and 2) a scale moat. Let me explain. Before the days of online shopping, the retail aisle was the only place to purchase products. A business that produced better products, convinced retailers that their products would sell, or had a large consumer following; usually was awarded shelf space. Product marketing was important, but access to shelf space; a distribution moat; was truly the underappreciated competitive advantage. As retailers grew from tens to thousands of stores, shelf space grew exponentially. Helped by these secular trends, CPG businesses who possessed this distribution moat had an unassailable competitive advantage. We are intimately familiar with P&G, Nestle, Unilever today.
CPG companies also leveraged this distribution moat into a scale moat. A growing business brought economies of scale. These companies purchased raw goods cheaper, built larger, efficient facilities, and spent less on transportation on a per unit basis. This larger footprint also brought scale advantages in advertising and marketing. When television was truly the most important medium, and therefore cost prohibitive for upstarts and smaller competitors, incumbents were able to leverage their large advertising budgets and low marginal costs to transform products into durable brands. A simple battery brought images of an energizer bunny, or a simple razor became the best a man could get, etc.
Sales and earnings grew for decades, dividends grew, and dividend growers became an investor’s best friend. More importantly, return of equity did not mean revert for fifty years. The Economic theory of mean reversion – high profits attract competition which lowers profits for the group - was debunked because newcomers couldn’t disrupt incumbents. These dual moats have stood the test of time so far.
But what happens when the paradigm shifts? Can terrestrial moats defend against air attacks?
Today, the consumer isn’t limited to the products sold in retail stores. E-commerce is 14% of total retail sales but growing at a rapid clip of 13-15% annually; while in-store sales are barely growing. Therefore, it is only a matter of time before e-commerce grows to 30-40% of retail sales. Finite retail shelf space is being replaced by infinite e-commerce aisles that can hold hundreds of thousands of products. Amazon today sells 450 million products. Therefore, as consumers today, we have access to an unlimited assortment of products.
The high costs of advertising and marketing aren’t quite the same barriers to entry they were in the past. Facebook, YouTube, and the like, are global platforms, where the cost to advertise is almost a fraction of its traditional competitors. Good storytellers have a cost-efficient avenue to introduce products to the entire world, almost over-night.
Marketplace platforms (Amazon, Ebay, Walmart, Etsy etc.) act as business incubators and accelerators. They provide end-end business services and a captive end market of consumer households. With fewer worries of building a supply chain or raising tons of upfront capital, entrepreneurs can focus on their core function of building great products. It’s no surprise that innovation is accelerating at a faster rate today than ever before.
While growth in overall retail footprint was a strong tailwind for several decades, retail today is in decline. We are in the early innings of store closures, as businesses come to terms with managing and optimizing the capital costs invested in store-fronts relative to declining per-store sales. The next recession will accelerate this trend of store closures.
Lastly, but more importantly, our preferences as consumers have changed. Instead of global, we desire local products made by local entrepreneurs. We want organic and fresh. We want different and authentic. This trend is incredibly strong and durable, is global in scope, and goes counter to what the great brand companies have built over decades.
The rules of the game are changing. The dual moats of consumer staple companies are under attack from secular forces which they weren’t designed to defend against. Can dividend growth continue in the future at the same rate as in the past? It is highly unlikely. We are in the early stages of Staples under-performance. Mean reversion is at the doorstep of the consumer staples kingdom at last….
This material does not constitute an offer or solicitation to purchase an interest in Latticework Partners, LP (the "Fund"). Such an offer will only be made by means of a confidential offering memorandum and only in those jurisdictions where permitted by law. An investment in the Fund is speculative and is subject to a risk of loss, including a risk of loss of principal. There is no secondary market for interests in the Fund and none is expected to develop. No assurance can be given that the Fund will achieve its objective or that an investor will receive a return of all or part of its investment.
This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the Fund. These projections are included for illustrative purposes only, are inherently speculative as they relate to future events, and may not be realized as described. These forward-looking statements will not be updated in future.
I am an investor and these are my personal thoughts on investing, behavioral finance, markets, and sports viewed through the prism of a Latticework