Consumer stocks: growth potential in coffee and pet food

By Manuel Zeuch and Sebastian Hofbeck, analysts in the DJE Research Team

Consumer goods are classics for investors. However, factors such as scarcity of raw materials, disrupted supply chains and inflation are putting pressure on consumer spending. On the other hand, structurally growing categories such as coffee or pet food offer opportunities, as does a steadily growing middle class in the emerging markets. So are consumer stocks still attractive? Or even right now? The analysts at DJE take a look at the current situation in the sector and explain where there is potential for growth.

Disillusionment after the pandemic hype

After more than two years of steady growth in the consumer (basic) sector, growth slowed last year. During the pandemic, companies with a robust supply chain and high availability of products and goods have benefited the most. In addition, companies with a high proportion of online sales (at L’Oréal, for example, this accounts for 28 percent of sales) and low sales from emerging markets benefited. Companies that are active in structurally growing categories were also in demand. These categories include pet food and coffee, among others.

The main challenges were the continued tight supply chains and the rapidly increasing input costs: Manufacturing costs make up around 50 percent of sales, of which around 80 percent are raw material costs. These increased by around 16 percent compared to 2021. To compensate for the difficulties, the companies have strengthened the supply chains, made production more efficient and flexible through more automation and also significantly increased prices; for the industry giants, these price increases were recently between nine and 13 percent.

Prospects remain attractive

In early June, the largest consumer goods investment conference was held in Paris, bringing together over 90 companies from the consumer staples, luxury goods, food and non-food retail sectors. Sentiment was more constructive than many investors expected as companies were more optimistic on volume development and further pricing adjustments. One of the main concerns of investors was the development in the US, one of the most important markets for many companies. A weakening is already visible there, for example in large-scale projects in discretionary areas, ie areas that can be postponed or even dispensed with (such as residential construction or DIY stores). Contrary to expectations, however, consumers in the USA continue to be (still) robust.

Despite the high price adjustments, demand remains stable and does not appear to be deteriorating any further. The unemployment rate remains low at 3.7 percent and consumer savings are still above 2019 levels. In contrast, European consumers are suffering from increased costs. Nevertheless, consumer confidence among European consumers is also developing better than expected, as measured by the European Commission’s consumer confidence indicator for the euro zone.

Growth engine China: Yes, but…

China is very important for the consumer goods sector, but is recovering much more slowly than many expected after the corona reopening. The purchasing managers’ index for China’s manufacturing sector came in at 48.8 in May, below the 50-point expansion threshold. This is only a slight rebound from the pandemic-hit December 2022 reading of 47 points. However, some companies that took part in the investor conference in Paris are now seeing a noticeable increase in demand in China. At the same time, various companies reported that Chinese customers are becoming more demanding about brands and their value propositions.

What to do with cost increases?

In addition, the focus was on the development of costs, which had risen sharply recently and weighed on company margins and profits. Most companies currently expect the pressure from rising input costs to ease in the second half of the year. Unilever expects net material inflation of €2.2 billion for 2023 as a whole, with two-thirds of the costs occurring in the first half of the year and one-third in the second half. This corresponds to a decline of EUR 4.5 billion compared to the previous year. Furthermore, positive volume growth is expected to return and margins to increase again.

Growth markets: emerging countries

During the pandemic, companies with a high proportion of sales from emerging markets have suffered greatly. These regions are now beginning to recover after the pandemic, although some are struggling with high inflation rates. At the conference in Paris, Unilever and Nestlé showed how important the emerging markets are for companies. The companies reported that sales growth in emerging markets was one and a half times faster than in developed countries and margins were significantly higher. There are a number of reasons for the growth, including an ever-increasing population that places more focus on affordable yet high-quality products. In addition, health-promoting products and goods that cover the daily nutritional needs are in demand.

The emerging countries will continue to be very interesting for companies in the future, since according to current forecasts the average economic growth should be significantly (one and a half to twice as high) as that of the industrialized countries. This increases prosperity and allows the middle class, which tends to consume more, to continue to grow in these regions: it is estimated that another 800 million people will join the global middle class by 2030.

Growth segment of pet food

In recent years, pet food and coffee have been two structurally strong growing categories. The global market for pet food is around EUR 115 billion and has grown by around 9% per year over the past five years. Growth is expected to continue at over 7% per year for the next four years. The largest pet food market is the US, which is 6.5 times larger than the second largest market, China. Animals have become part of the family and for many a kind of “substitute child”. This is also reflected in the development of spending: The Pet Products Association in the USA estimates that spending on pet food and “treats” in the USA will be USD 58 billion in 2022, compared to USD 36 billion in 2019. This corresponds to a growth of 18 percent per year. In addition to the strong growth, the margin level is particularly attractive – it is one of the highest in the sector.

Coffee is always good – even cold

The global market size of USD 495 billion shows that coffee is a popular drink. Two-thirds of consumption is accounted for by the category away from home. Over the past 40 years, the market has grown steadily, regardless of the macroeconomic cycle. Innovations such as different flavors depending on the season and the expansion of the range of individual cold drinks play an important role in this. The American industry leader generated around 70 percent of its sales in the USA from cold beverages in 2022, compared to around 45 percent in 2018. The category as a whole has grown at an average of 7 percent per year over the past five years, attributed to the increasing consumption of coffee per person and the “premiumization” of the offer.

North America and Western Europe currently account for around 50 percent of global coffee sales. However, the North American market has only grown in the low single digits over the past five years. In the meantime, growth is increasingly coming from the emerging countries, above all from the Middle East and Africa. There, the category has grown by 10 percent per year for the past four years. According to Nestlé, emerging markets still have enormous potential in the coffee sector. Current consumption of coffee per person in China, India and Africa is 32 cups, well below the rest of the world, where it is over 200 cups per person. Nestlé has continued to expand its presence in the coffee segment (which accounts for around 11 percent of group sales) in recent years, including through a marketing partnership with the American industry leader. Its products now account for about a third of all coffee sales in the US – overall a smart move by Nestlé.