For several years now, investors have been wondering when consumer stocks will finally bottom. Once foundational safeguards across many portfolios and mainly bought for their dividends, and not their share price appreciation (though welcome), defensive consumer stocks have created strong headaches for those who bought at high multiples, ignoring the big fundamental shift that happened (Financial Engineering readers have been warned about). Naturally, at some point, there will be a bottom, though. Are we there yet?

Summary and key takeaways from today’s Weekly
– Many popular consumer stocks have shocked their investors with huge negative returns.
– There’s seemingly no end in sight — for informed readers it is not such a huge surprise.
– I tell you why I still remain skeptical — and where it might make more sense to look.

Longer-time Financial Engineering readers know I’ve been very negative, pessimistic, bearish, or whatever you want to call it, about pretend defensive consumer stocks.

First, it was primarily due to in my view excessive valuation multiples.

However, with the last big inflationary wave, mainly during 2022, I noticed the old rules do not apply anymore. Companies with mainly branded products lost touch with consumers and their pricing power. Volumes declined, margins came under pressure. The remedy? Aggressive price hikes and even more lost business.

Accordingly, formerly robust balance sheets turned out to be much more aggressive than many thought (and still think).

This altered any formerly relevant thesis.

What worked out in the past, was destined to fail. On twitter, I mainly received negative and skeptical comments about my shared views regarding food, beverage, alcohol, household appliance and personal care companies and their stocks.

While of course not with a 100% hit rate, directionally I was right. Many of these stocks continue falling even until this day. Broad diversification in this sector was practically useless. No matter, whether markets rise or fall, whether there is risk-on appetite or stress and uncertainty — in the past, the latter was a period when such stocks excelled.

In this weekly, I am taking a big-picture view to access whether we might have reached levels of desperation with too much pessimism.

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Bargains or no gains?

If you had asked me four years ago, whether defensive consumer stocks could fall 50% or even much more, I’d likely have been skeptical.

With my wait-and-see approach, I definitely knew that it was not the time to buy. Valuations were too high, while the consumer environment went through a fundamental shift. In short, the former rules of thumb or general wisdoms did not make sense anymore.

However, I did not see that coming on this scale.

I must clearly admit that I am surprised these stocks have fallen so much, indeed, when looking back several years now. But monitoring on a constant basis as I do, the negative developments made more and more sense, so that on the bottom line I am not surprised now in hindsight when piecing everything together.

But glad I followed my instinct and the results of my analyses.

I did not see it this way all along on the way down. 👇

Maybe we have reached this terrain now?

Below is a selection of some popular names, all of them dividend stocks. And, all of them seemingly having defensive business models and “strong brands”.

All charts show the price performance over the last ten years.

Only The Marzetti Company (ISIN: US5138471033, ticker: MZTI), formerly known as Lancaster Colony, and Colgate-Palmolive (ISIN: US1941621039, ticker: CL) did not collapse — but their performance was not good either.

For those who don’t know, Marzetti is producing stuff like garlic bread, salad dressings, croutons, frozen food, etc., perfectly fitting in. They held up better for longer, but now fears surround them as well. I also could’ve thrown in other perpetual losers like Campbell’s (ISIN: US1344291091, ticker: CPB), the alcohol companies, or Kimberly-Clark (ISIN: US4943681035, ticker: KMB) from the household sector.

But I think the message is clear.

The practically most defensive names got absolutely slaughtered.

When seeing charts like these — respectively rather the red numbers, as I do not really care about charts as such — sometimes I have certain questions in my head.

Is the stock now cheap enough?

Is everything bad already priced in?

Are expectations too pessimistic?

Could the dividend be cut?

What needs to happen to turn this one around?

And so on, and so on…

Now I saw this headline — which was the trigger for this weekly, together with someone asking me on twitter about some consumer stocks (whether they could be worth a look after having fallen so much, offering a historically high dividend yield).

As you can see in the snippet above, the narrative of oversold consumer staples stocks is based on the RSI, a technical indicator — nothing fundamental.

Anyway, this triggered me to have another look and to write down my results, as I know many people are interested in these stocks. Maybe by thought are helpful here or there. The motives might be slightly different case by case, but generally speaking it comes down to high dividend yields, low-looking multiples, and so and so high share price declines.

In other words, the hope to catch the bottom and pick a bargain.

If it only weren’t so costly to pick up garbage… In a nutshell, the core problems I have laid out in past weeklies, in my view have NOT been solved. As if this weren’t enough, we are facing another inflationary wave, potentially (likely) hurting these companies even more. I am convinced consumers still will not care about brands — whether hip or legacy — but try to get the best bang for their buck.

Private labels will be better off — that’s what I think.

And that’s why I would not blindly assume the current valuations are extraordinarily cheap. First of all, PE ratios do not cover debt — many of these companies have huge debt loads. I mean really huge, as I will show below. And second, barely anyone talks about this, don’t take the current earnings for granted. Not only due to cost inflation pressuring margins, but also potential pricing wars.

Impossible or unthinkable?

Branded products have lost market share through aggressive price hikes, because margin protection was the credo.

But what if now market share and closing the gap to private-label offerings will be the new go-to strategy? Many will likely be surprised, but it makes absolutely sense. These companies need volume and market share as they are mass producers. Mass production lives off — well, easy guess — volume. Else, unit costs rise because fixed costs are spread on lower counts.

So, it is possible — or should be taken into serious consideration — that at least some of these companies could sacrifice their high margins, trying to be more competitive on the pricing level. Not everyone will be successful, though.

Some will gain market share and expand sales, others will fall back.

The losers will then suddenly turn out to still have extremely expensive stocks when debt comes on top and the E in the PE ratios gets smaller.

Let’s now compare these names on a few key metrics.

Company	PE ratio (forward)	EV / FCF	net debt to FCF
General Mills	10	18	8x
Conagra Brands	9	20	10x
Marzetti	18	24	small net cash
Kraft-Heinz	11	17	7x
Colgate-Palmolive	21	24	2–3x
Clorox	15	21	4x
Kimberly-Clark	13	19	3–4x (pre merger with Kenvue)
Campbell’s	11	18	9x

^{source: my calculations based on latest data from tikr}

The numbers are aimed to be approximately and directionally right, not to the last decimal. Nonetheless, it might be shocking to see that:

• The “cheapest” of these companies has an EV / FCF multiple of 17
• many still trade for close to or even above 20x
• robust balance sheets (in most cases) — maybe elsewhere

These observations gain in importance when factoring in that sales, margins, profits, and / or free cash flows are not growing anymore. Some fumble around with adjusted figures, but the reality is closer to no growth.

And that’s even the better situation be in.

If negative growth sets in or persists where it already is, then the multiples become automatically higher and the stocks more expensive without shares moving at all.

Or from a different perspective, if business results and multiples fall, so do these stocks usually either. The market prices growth and profit expectations. If the expectation is the business will decline — is it really surprising these stocks fall and multiples compress? Higher multiples mean more growth.

Second, the in my view still widely underestimated or even ignored issue: debt.

Debt with my metrics is not only much higher than the reported phantasy net debt to adjusted EBITDA figures. FCF pays debt, not EBITDA. And, debt stays until it gets repaid. But these companies in most cases do not repay anything, they accumulate even more — often for flights into mergers (see here) or to appease shareholders by buying back stock and / or paying dividends.

Mr. Market sends these stocks lower anyhow.

Third, as I wrote in this weekly (see here), the asset side of most balance sheets is very likely inflated. This is what I mean with “aggressive balance sheets” — high and concrete debt, high but vague and questionable asset quality.

Until here this sounds very negative, maybe pessimistic. Agree and acknowledge.

But the performance of these names tells you what you need to know. It is unlikely that Mr. Market is too stupid, overlooking the gigantic value that retail investors seemingly see, (unconsciously) pretending these were some secret golden nuggets.

I also know and am happy to admit that there are a few cases that did better or even comparatively well. Examples are THE core defensive and dividend stock, Coca-Cola (ISIN: US1912161007, ticker: KO) or Arm & Hammer producer Church & Dwight (ISIN: US1713401024, ticker: CHD).

One could say that I missed or overlooked these names.

I do not see it this way. They are too risky for me because the multiples are too high — so are growth expectations. The fundamentals in my view do not cover such growth premia.

Before, people could not imagine General Mills, practically THE breakfast company, to collapse in the way it did. Everything is possible, including the unthinkable and unimaginable.

Nonetheless, I published a few reports for my members with carefully selected ideas to cover this sector. Here’s a brief overview:

√ At its core, I would describe it even as a very defensive consumer business, independent of which brands consumers buy. This interesting setup alone has a clear growth path. 

√ What comes on top is … higher energy prices.

Huh?

Usually, higher energy prices are bad for consumer stocks as they beef up costs. In this case, it might act as a tailwind, though an unexpected one, when looking only at the surface. 

So we have a reemerging growth story in a defensive core sector, strengthened and supported by regulatory barriers, and a surprising beneficiary from higher energy prices.

When interest is low, it is time to have a look.

This time is now.

Conclusion

Many popular consumer stocks have shocked their investors with huge negative returns.

There’s seemingly no end in sight — for informed readers it is not such a huge surprise.

I tell you why I still remain skeptical — and where it might make more sense to look.

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