The Evolution of the Consumer Staples Sector
Rob Almeida and Genevieve Gilroy, consumer staples sector leader, explore the shifting dynamics in the consumer staples sector in this podcast episode. They also discuss the importance of a collaborative, global research platform in differentiating opportunities across categories.
Rob Almeida: Welcome to another edition of the Strategist Corner podcast. I'm your host, Rob Almeida, portfolio manager and global investment strategist at MFS®. We live in a fast changing world, with an exponential growth in information. While of course, being more informed is better than being less informed, the vast amount of new information is making a bit harder for investor to distinguish between noise and long-term investment signals. So my goal with these podcasts is to bring forward directly to you insights on important topics from our global research platform to help get to what is financially material. Technology and mobile devices have obviously changed society in a lot of ways from how we communicate, spend leisure time, shop, interact with one another, work and so on. It's also democratized information. We can fact check price, check quality, check goods with ease, accuracy and speed. We not only know what something costs and where to get it most cheaply, but how it was made, where it was made and the contents it contains.
This has had a profound impact on many industries, particularly in an area where we all traffic with regularity, consumer staples. For decades, this sector possessed relatively low product obsolescence risk as big brands dominated shelf space, wallet share and profit pools. Now in recent years, however, the landscape has changed, barriers to entry have fallen, which my guest today elaborates on, due to technology and social media that has opened the door for new challengers. We all must eat and drink. And demand for consumer staples is constant in that way, but what we eat and drink has changed and how much we're willing to pay is changing. I'm delighted to share my conversation with US consumer staples analyst and sector leader, Genevieve Gilroy, as we explore the changing risks and opportunities inside staples. Genevieve, welcome to the podcast. Let's just jump right into it. How long have you been researching staples companies and when did you become sector leader for MFS?
Genevieve Gilroy: Sure. I started at MFS in 2011 in the equity department. I became an analyst in 2015 and started covering some more small and mid-value names in the ag and grain space. Shortly after that, I added some kind of GARP-ier, large cap consumer staples coverage. So these would be the non-alcoholic beverage companies like Coke and Pepsi, which had a bit more of a global overlap. And then I joined the tech team in 2016, and ever since then I've picked up a whole range of semiconductor companies and semiconductor suppliers. Around that same timeframe, I moved into the sector leadership role on the consumer staples side. So today I'm still covering consumer staples and in the sector leadership role on the consumer staples team, as well as covering a whole host of semiconductor names.
Rob Almeida: So I know sector leader can mean different things at different firms. What does it mean in MFS? What are your responsibilities in that regard?
Genevieve Gilroy: Sure, yeah. I'd probably put the role into two buckets, which I'd say would overlap entirely. The first, I'd say the primary objective of the role is really to act as a steering tool towards trying to hone the discussions that we're having across the firm about consumer staples names towards the objective of all of our global funds owning the best risk-adjusted ideas that our analyst team has for generating alpha over the long term. And so a huge function of that role is planning our weekly global sector meetings. And so that's where all of the analysts on the global staples team and portfolio managers — a big group of portfolio managers across the world — really come together in one space to try to talk about all things consumer staples. So that could be anything from a new stock pitch from an analyst or a global stock comparison or some thematic research or just various implications for our portfolios. And so a ton of work is done by our analyst team that goes into each of those meetings. And the sector leader role is really to focus all of that and expand that work into a global discussion that benefits everyone in that team environment.
And then the second piece of the sector leader role is really acting as the buy/sell decision maker on our analyst-driven funds. And so we have a number of different analyst funds across the firm. They all have different strategies, but all of them manage real client money, and it's the sector leader's job to listen to the analyst team and make final buy/sell decisions to construct a portfolio within each of those respective sectors out of the best ideas that come directly from the analyst team. And so PMs, they pay a lot of attention to those funds as a signal of what our on-the-ground analysts and teams are thinking. But again, this is real client money that the sector leaders on each sector team are managing and have buy/sell decision making over that has just as much gravity as any of our other portfolio-managed funds.
Rob Almeida: Perfect. Thank you. I like the way you phrased that because the rest of the podcast we're going to get into some of those things that you and the team are talking about and then, specifically, areas where you're active, areas that you're leaning towards and areas that you're leaning against. So I like the way you laid that out. Thank you. So the firm, we've been pretty large owners of staples companies for years, and we're going to get into the nuances and the changes that have taken place. But talk a little bit about what were the historical draws to the sector? Why were you and investors been attracted to staples for so long?
Genevieve Gilroy: Yeah, absolutely. I mean, first, consumer staples just really — it starts with the duration of cash flows. And so these businesses, I think, first can be described as defensive. And so, you're thinking about a group that over time has very limited cyclicality but has driven considerable moats over time by building brands that drive duration of fairly stable and defensive cash flows. And so, I think consumer staples within a portfolio, when at appropriate valuations, can play a nice role of defensive long-duration streams of cash flows that can balance other, maybe, higher risk opportunities.
Rob Almeida: So we're going to get into GLP-1s later. And I've heard you talk about this in the sector meetings. Portfolio managers have been talking about this, but a lot's changed in the last 10 years. Maybe describe for us what some of those factors were that have altered the landscape a little bit.
Genevieve Gilroy: Yeah, definitely. I'd say for a group that has a reputation for being predictable and defensive, it's definitely really interesting to walk through just how much has structurally changed versus call it 15 years ago or pre-GFC. It's a really interesting juxtaposition versus the semiconductor space, for example, where everyone's aware of how quickly things can change, whereas staples, it's quiet, it's slow, it's steady change, but it can be really powerful and just as important for alpha generation to stock pick around. And so I think versus 15 years ago, in the context of defensive cash flows and long duration, it really can be boiled down to slower gross, which in itself I think can be boiled down to how the barriers to entry in that space have just structurally declined.
Rob Almeida: And what drove some of those declines? Is that technology and social media, the innovation or lack thereof? Help me understand that a little bit.
Genevieve Gilroy: Totally. I think the first and the most obvious piece is probably e-commerce. And so while the consumer retention to the shelf at Amazon and practice is not exactly infinite, but brands versus 15 years ago, you don't live and die buy in-store shelf space. So where scale used to be get scale, e-com puts smaller and larger brands on a much more even playing field and puts more power in the consumer's hands to choose which brands are worth their time. I'd also say just as important are the brands themselves. Staples companies, again, live and die by the brands that they built, which is what drives remote. And historically building a brand, it was very high barrier to entry, and that was driven by the advertising. And to build a brand via advertising, historically you needed scale to have the budget to even build that, right? You needed to be able to work with ad agencies to reach your audience. You need to have budgets for television ads, right? Scale, again, begot scale historically, and that's what got you into the grocery store again. And so I think, so between the ability to get on shelf, the ability to build a brand via advertising, the barriers to both of those have declined. And social media, of course, it's changed the landscape of advertising. But again, a lot of brands, the younger generations are feeling more connected to brands that are built entirely on social media
Rob Almeida: By an influencer.
Genevieve Gilroy: Oh absolutely. Or just a place where they can have a better and more natural and genuine connection with a brand that can be built on social media with authenticity, with purpose. And consumers are finding that really refreshing. So I think across the board, whether that's via the distribution, the brand building, the advertising, the barriers to entry have declined and made it much easier for small brands.
Rob Almeida: So a lot of things in life, technology came in as a disruptor, and it just altered the landscape. And like you said, it reduced those barriers where now maybe an entrepreneur or new organization could come in with less capital and compete. Is that fair?
Genevieve Gilroy: Yeah, absolutely. And I think also just innovation has changed as well. The landscape of work has changed during the prime of the baby boomer generations, consumers, consumer brands and advertising behind them. That was the most prestigious place to work, right?
Rob Almeida: Interesting.
That was where our most driven and talented young people wanted to work. People 30 years ago, maybe they moved on to finance, and then 15 years ago they moved on to Silicon Valley. That's where those places of true kind of fiery spirit of innovation are really living these days. And you're finding fewer of our young, talented people wanting to live and work at these big brands. They want to work at startups, and they often want to work at small brands. So some of that is structural too, but I think it all comes together to make it even more important as we're looking at consumer staples, companies in which names to own just to stock pick between those. And we see a lot of differences between companies that have categories and brands that are resilient in the face of all this change and those that are more at risk.
Rob Almeida: Well, and you've talked about that before. Internally we have advantage categories and disadvantaged categories, and we'll come to that later. Maybe sticking on the disruption theme, obviously there's a lot in the media around GLP-1s, particularly in health care, and it's affected your universe and staples, maybe excluding the science behind it, neither of us are doctors, but just talk about how GLP-1 has, we know how it's affected consumer staple stocks already. We've seen that in the marketplace, but maybe how you are thinking about it in the team internally?
Genevieve Gilroy: Definitely. It's amazing. Short GLP-1 popularity and interest has exploded. The questions around implications for food companies are certainly justified. I think we've maybe been perhaps surprised as we talk to our consumer cyclicals team that staples companies thus far have been getting maybe a bit more attention than the QSR restaurants have been getting. But nonetheless, it's very important to assess the risk there. And we started working with our health care team on really sizing the risk, and it's really early, but definitely important to acknowledge that the range of outcomes on all this is really wide, that it's wide in both directions. So not just discounting a bear case where adoption of these drugs could be super widespread, but also a lot of watch items in between then that could prevent that from happening. So again, range of outcomes very wide. We've talked to all of the food companies across the board.
They're monitoring this risk. They see it as a manageable risk, but it's something that we keep watching. And I think from there, the work that we're doing is differentiating across companies. And so first of all, obvious differentiations, personal care, household products. These are categories that just do not face the same risks that food companies do and it's basic. And then alcohol and tobacco probably somewhere in between. And then from there, we're looking across portfolios, we're looking across geographies. We see this as a greater risk for companies that are more tilted to the US than companies that have greater exposure outside of the us.
Rob Almeida: Is that because it's being approved here faster or why would that be a greater risk for US names?
Genevieve Gilroy: I think the adoption is certainly in the curve, just faster, just looks a lot faster in the US, and I think there's different insurance considerations as well for companies in the US but also something that we're looking at is across categories too. And so we think there's difference between maybe more impulse-driven categories than categories that may be more meal based. But then again, it just is important to layer on the valuation piece to it. So as we're looking at GLP-1s, they've been both a risk and an opportunity. So as a sector team, there's been periods of time where we've already added to names where the GLP-1 risk seemed maybe overly punitive on a relative basis. And there's times where we've trimmed where the GLP-1 risk wasn't fully discounted. So again, it's a risk that we're monitoring, but we view as, at times, actually creating opportunities for us as well.
Rob Almeida: So I'm hearing a materially changing backdrop for staples as you've described now, maybe high level, what types of categories or industries are better or worse than others?
Genevieve Gilroy: I mean, I think I'd start with we're looking for categories that we still think have an opportunity to grow longer term. And so that could be through a number of different ways. That might be through rising global occasions, whether that's per cap consumption growing in developing markets, or maybe that's through premiumization where the consumer actually sees a tangible benefit to quality and associates that with the brand. We also like categories that are less discretionary in nature, but we also see opportunities in categories that have structural tailwinds. In one area that we've liked is spirits, where premiumization is a longer-term theme or snacking where the consumer is increasingly moving from three meals a day to a rising number of snacks throughout the day.
And we like categories with lower private label exposure. So these are categories where the consumer is really seeing the value that the brand brings and the quality that the brand brings to the product longer term, which we think should lead to structural pricing power. A great example of all of this, I would say the category is toothpaste, right? It's a category where there's rising developing market occasions where premiumization is leading to better consumer outcomes. And where we think the brand itself has resiliency in a declining barrier to entry world, just as the trust in that brand's performance matters.
Rob Almeida: Right. That makes sense. Okay. Well, you've been so gracious with your time. Last question. I know you're not an economist and you certainly don't predict interest rates, but we're recording this in early May and we've had some surprising, let's call it inflation prints, but I don't think they were surprised for anybody that buys food or buys gas or pays rent. So given increasing food prices or just increasing prices of staples and inflation context, how does that flow through in your models and margins? And I guess maybe how do you think about all that? Is it good or bad?
Genevieve Gilroy: Yeah, absolutely. I mean, we've already seen through 2023 and into 2024, clearly all of these brands have taken unprecedented levels of pricing, and we're seeing the consumer reacting to all of this inflation. I mean, to be clear, for the most part, across consumer staples, the prices were higher because the input costs for all of these companies were higher. So these companies were certainly protecting their dollar profits but wouldn't say we're seeing exploitative behavior towards the consumer just protecting their own profits.
Rob Almeida: It's consistent with their internal costs.
Genevieve Gilroy: Sure. But clearly still unprecedented levels of pricing and the consumer basket is much more expensive than it was before Covid. And we've seen volumes pressured for a lot of companies, particularly in the last 24 months or even more so in recent quarters. And we've seen the lower income consumer reacting. We're seeing some consumers changing where they shop. Increasingly they're going to dollar stores, club stores where they're finding more value. At the same time, companies are still calling out that certain consumers are still continuing on the trend of premiumization. So we're seeing some bifurcation of the consumer. But I think what we're looking for in this environment is a lot of the same things we were looking for before this pricing environment, but we think should continue to be an advantage in this environment, is low private label exposure, reasonable starting price points, less discretionary categories, and I think categories also where companies have opportunities to use PAC management, size, just to hit those price points that make sense for the consumer and adapt to their affordability.
Rob Almeida: Yep. Okay. Well, thank you. This has been great. I think if I can try to summarize, and correct me if I get this wrong, but what's been an attractive quality of the sector for many, many years was its stability of cash flows. And what's changed in the last 10, 15 years is technology and innovation and allowed for more competition and more competition creates more, maybe, profit dispersion, wallet dispersion, if you will. And it doesn't change maybe our overall attractiveness to the sector, but it does increase the, I guess maybe the importance of getting names right and avoiding names that might not fare as well. Is that a fair assessment?
Genevieve Gilroy: Absolutely. I think it's more important than ever to differentiate between categories, to differentiate between companies and to differentiate between valuations, to look for those opportunities for a sector where there's, I think, a lot more dispersion in fundamentals than we've seen historically.
Rob Almeida: Yeah. Well, you've been busy helping us a lot between the AI webcast we did a few weeks ago, this. I really appreciate your time. Thank you so much.
Genevieve Gilroy: You bet.
Rob Almeida: Thank you for listening to another edition of Strategist Corner Podcast.
The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.
57842.1