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By Yona Rom
What’s next for the consumer and consumer-related stocks?
At the onset of 2022, we believe various consumer businesses were emerging from the pandemic with some degree of “over-earning.” Whether 2020 “stay-at-home” beneficiaries (connected fitness, e-commerce) or 2021 reopening “revenge-spend” recipients (travel-related, restaurants), there were examples of irregular earnings power largely due to supply/demand imbalances.
Hindsight is 20/20, and while we believe it is clear now that most of these businesses would not sustain such elevated demand, managements and investors struggled to forecast a normalized environment. In January, analysts talked of a strong consumer in the face of rising inflation, with little mention of consumer cohorts, “trade-down” implications, increased promotions or excess inventory—key issues facing many companies today. In fact, over the last six to 12 months, many businesses doubled down, investing in supply chain capacity, manufacturing capabilities, inventory and marketing—all in a consumer environment propped up by exogenous shocks, including massive fiscal and monetary stimulus that elevated savings levels.
Fast forward to today and the environment has changed markedly. The aforementioned shocks—coupled with the Ukraine war-related commodity spike—have driven ongoing inflation, including a 9.1% CPI reading in June. Consumer weakness and trade-downs to less expensive goods are increasingly apparent (especially at lower incomes levels), while managements have had even more trouble forecasting future earnings, with select companies lowering guidance or pulling it altogether.
However, while external shocks and subsequent business decisions drove inflation, we believe the resulting effects will likely be key drivers in taming inflation. After all, while inflation has led to higher product pricing and revenues, numerous companies are also seeing volume declines—with the term “elasticity” now back in the management vocabulary. Inventory levels continue to build up across the board, and while about 20% of this increase can be attributed to inflation and supply chain costs, aggressive inventory buying has now initiated a return to normalized promotional levels (i.e., discounting). Oversupplied inventories, combined with a decline in unit demand, could be key drivers of disinflation; similarly, various commodity costs are down 20% – 30% over the last three months.
In this vortex of change, few have strong conviction as to what comes next for the consumer; however, the current landscape highlights the importance of understanding the sustainability of company business models. In our view, while 2020 and 2021’s exogenous shocks drove inflation, these same effects could help tame it, ultimately leading to an environment with more predictability for businesses, consumers and investors.
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