By Russell Pointon, Edison Group
As the winter months settle in, the consumer sectors continue to face the headwinds of inflationary cost pressures and low consumer confidence. Despite the frosty outlook for consumer demand, our analysis of valuations reveals a swathe of value opportunities in consumer stocks.
A cold winter for the consumer market?
The cyclical sectors are feeling the effect of deepening macroeconomic uncertainty. With climbing interest rates joined by the growing threat of a global recession, pressures on consumer demand are set to intensify with spending likely to be significantly squeezed.
Arising from global economic and pollical circumstances, a cocktail of trouble is taking its toll on the prospects of businesses across the UK consumer sector. Rising costs, the fall-out from the “mini budget”, and the subsequent government U-turns have induced an atmosphere inherently hostile to consumer spending, precipitating the prospect of a recession in the UK as we move into the winter months. The same is true of European and North American markets, with continued economic uncertainty and rising energy costs restraining consumer spending.
An opportunity for investors
Despite the troubled outlook, investors should not resign themselves to abandoning the consumer sectors. Our recent Consumer Watch report highlights a swathe of consumer companies now available at significant discounts to their historic valuations.
Our findings identify more than 100 companies that appear to fully discount an economic downturn. The list includes household names such as Fevertree, Watches of Switzerland, Loungers and Hostelworld. Beyond the UK, Savencia, SMCP, and VRG are among the featured European stocks while Century Communities, Dave & Buster’s Entertainment and LoveSac are lowly valued in the US.
For each of these businesses, their share prices appear to be discounting a significant downturn, giving investors value opportunities. Moreover, with consensus expecting each of the highlighted names to generate positive free cash flow (FCF) across 2022 and 2023, we believe they offer good value.
This identification of value echoes the finding of our recent ‘IPO Apocalypse’ note. The research concludes that a toxic combination of market sentiment, slowing growth, rising inflation and belatedly hawkish central banks has left 84% of IPOs trading below their issue price. And at these levels investors could uncover a swathe of valuable opportunities.
No single outlook for consumer stocks
Through our research we have also noted that although Q322 saw widespread underperformance across the consumer sector, with the UK market witnessing a negative return of 5%, separate sub-sectors demonstrate varying levels of performance.
In the UK, the internet and direct marketing retail stocks were the weakest preforming sub-sector. The 29% decline in this sector in Q322 continues the weak performance seen through H122, taking the cumulative decline for 9M22 to 68%. We believe this was a rational response by investors, given forecasts for greater losses in aggregate, negative FCF generation, and increases in interest rates.
The food products sector has also seen a sharp decline, falling by 18% during Q322, with 22 of the 26 companies seeing lower share prices as consensus CY22 forecasts for revenue increased by 2% and EBIT forecasts were downgraded by 4%.
On the other hand, some sub-sectors have significantly outperformed other stocks. Consistent with Q222 trends, the beverages, personal products, household products and textiles, apparel & luxury goods sectors all outperformed. The hotels, restaurants and leisure sector experienced a revival, moving from one of the worst performing sectors in Q222. With widescale negative share price moves in the sector during Q322, its rise was mainly attributable to the performance of a small group of stocks including Flutter Entertainment (share price +21%, CY22 EBIT estimate -2%) and Compass (share price +7%, EBIT estimate +4%).
A cautionary note
While these findings offer some cause for optimism amongst investors, our Consumer Watch report also advises caution in approaching the consumer sectors. Given the obvious pressures on consumer spending and company costs, the strength of profit growth estimated in CY22 and CY23 for most sectors feels somewhat optimistic.
We caution that profit expectations could yet be too optimistic and that stocks may be vulnerable to further downgrades. Consensus estimates still suggest year-on-year operating profit growth for consumer sectors of 18% in North America, 8% in Continental Europe and 20% in UK in 2023.
Meanwhile, a rapid recovery in sentiment towards the consumer sectors is unlikely, given continuing profit estimate fears and central banks restricting the money supply to dampen inflation. This might restrain any upward move in the sector or in the most highly valued stocks.
Nevertheless, the identification of over 100 consumer companies with stock prices unreflective of their fundamentals highlights the potential value and significant opportunity for investors.
