‘The greatest danger in times of turbulence is not the turbulence; it is to act with yesterday’s logic’ – Peter Drucker
H1 2019 has been on average a fantastic period for FMCG companies: Growth accelerated, profit stabilized, market caps soared and some companies confirmed their recent spectacular turnaround/ performance improvement (e.g. P&G, Nestle).
Net, we are far from a sustainable turnaround across FMCG verticals. Sustainable success will come down to FMCG leaders’ ability to not only address present-forward growth opportunities (segment, channel, geography) but also to transform their companies to address the structural changes in the industry (future-back risks and opportunities) starting with (but not only) the lowering barriers-to-entry and the redistribution of profit in the value chain. That is what we call future-proof growth and that’s increasingly the challenge of all CEOs in our industry.
H1 2019 key details and analysis below:
1) A narrowing Growth Gap
Clearly, on average, the sharpened focus on Growth (with unprecedented portfolio renovation efforts, reinvestment and aggressive capital reallocation – helped also by the return of pricing) is starting to pay off (analysis per vertical below)
2) An overall growth acceleration but a mixed growth picture across verticals and a plateauing profitability despite record unit revenue gains
The revenue and profit growth development across verticals continues to be extremely uneven and reflect mostly the specific challenges that each vertical faces (cf. sections below dedicated to each vertical for more details) but could be explained by 2 main drivers:
i) First and foremost, barriers-to-entry (mostly impacted by capital intensity and exposure to channel shift)
ii) Consumer emotional involvement
Another point worth mentioning is the increase in the cost of doing business (commodities inflation, trade spend inflation, increasing A&P, increasing investment in digital and e-commerce…) across all verticals is obvious as profitability is plateauing despite a growth acceleration and unprecedented unit revenue gains. Household and F&B are clear stand-out.
3) A record increase in market capitalization pushing average P/E premium at an all-time high despite ‘the worst profit outlook ever in the induy’str
The performance of those top 5 FMCG companies has been outstanding but clearly market caps soared also because of lowering interest rates and low US bonds yields. Illustration of that is the P/E premium of European Food and HPC stocks is currently at a record high 67% vs the rest of the market (cf. the Exane BNP chart below). Last time the premium was so high was just before Lehman Brother collapse. As a leading financial analyst puts it: ‘the sector has never been so expensive while its outlook has never been arguably so worse’. We could not agree more.
Looking at the top stock under-performers, they suffered from different issues:
4) A likely inflection point in M&A activity
This still needs to be confirmed over H2 but clearly M&A deals (volume and value) are significantly down YTD vs. YAG but also vs. last 2 years. Key reasons:
In the end, 2019 may well mark an inflection point in M&A in the FMCG industry.
5) Top FMCG retailers: Decelerating growth, continuous profitability erosion for the largest retailers and further profitability erosion ahead
If on average growth and profit momentum are positive, revenue growth is now decelerating and the majority of retailers saw a further erosion of their profitability, especially the largest ones (Walmart, Carrefour, Walgreen). Reasons are well know (sell-out price deflation, margin destructive e-commerce, increased investment in IT and infrastructure to adapt store footprint, market share dilution driven by channel shift…). We predict the profitability of EU/US grocers will trend to 1.5% by 2023-25 as grocery will be hit by the e-commerce cliff in both regions (dedicated article to follow).
Clearly European retailers are the most challenged (lowest growth, lowest profitability %). If the US retailers seem healthier, they still display a profitability level lower than 5 years ago and seem extremely vulnerable to the channel shift (e-commerce weight on grocery is currently only mid-single digit)
Extreme example remains Carrefour France that lost 80% of its profitability over the last 5 years; despite undoubtedly having tried to pressurize FMCG companies to offset this decline.
As predicted, while legacy grocers profitability keep eroding, the profitability of hyper-scale players keep soaring benefiting from network effect on cost side (last-mile, operating costs) and on revenue side (consumer acquisition costs, advertising, private labels…).
Best illustration being now Walmart/ Amazon (excl. naturally AWS). We already see this change happening while the e-commerce cliff is still few years away. But when the e-commerce cliff materialized on grocery in the US (most probably by ~2023), it will not be surprising to see Walmart US at 2-3% EBIT and Amazon (excl. AWS) >7% EBIT despite their considerable investment in last-mile and free shipping.
6) F&B: A growth acceleration and eroding profitability despite record unit revenue gains. US-centric Food companies suffered most
At the surface, growth has been accelerating on the F&B vertical but it has never been so unevenly distributed across companies (category/ country footprint being the first key driver along with resources allocated on growth: portfolio renovation and bolt-on acquisitions) and this acceleration has been mostly fueled by unit revenue gains (73% of the revenue growth) prompting us to question the sustainability of both the revenue growth and the profitability level (without those unit revenue gains, profitability would have dropped for most players by on average by 257 bps – Hormel and Nestle being exceptions).
If there is a strong performance to single-out in the F&B vertical, it is Nestle. If much more still needs to be done, the pace and the scale at which the CEO (Marc Schneider) and the CFO (Francois-Xavier Roger) have been reallocating capital to transform Nestle portfolio is unprecedented and has already yielded results (revenue, profit and market cap wise).
7) Alcoholic drinks: Party is still on (except for MCBC, highly exposed to the challenging US beer market). Unequal ability to offset commodity inflation
We often get the question: why does the alcoholic beverage vertical perform better on average than the others? Mostly because of:
i) the relatively higher barriers-to-entry (higher asset intensity – in the bottling but also in the distribution; local scale remains a key success driver especially for low value categories such as beer; the highly fragmented on-trade channel tends to require scale to win – although hyper-differentiated players increasingly succeed to break in the channel; sometimes key players are vertically integrated – literally ‘owning the pipes’…),
ii) the relatively high(er) consumer emotional involvement (especially on spirits)
iii) the diversified geographic footprint of most players taking advantage of large high-growth developing markets (LATAM, SEA, Africa) on those categories.
This broad-based strong top-line performance hid in H1 2019 an unequal ability to offset commodities inflation (e.g. Carlsberg vs. Heineken) showing also that pricing power should not be taken for granted on the vertical.
Finally, H1 2019 Molson Coors profitability evolution (-570 bps) is the perfect illustration of what can happen when commodities inflation get compounded with mid-single digit volume decline on a category reputed for its high fixed costs (comparatively at least to other FMCG verticals): brutal.
8) Contrasting Beauty Personal Care (BPC): Out-performance driven by China, Travel Retail, Skin Care & Luxury. Everything else suffers from channel shift
If there is a vertical where managing for future-proof growth takes all its meaning, it is BPC. BPC is going through fascinating times with on one hand extremely polarized growth engines (China, Travel Retail, Skin Care, Luxury; most but not all being interrelated) and on the other hand, areas of increasing structural challenges mostly driven by the channel shift (EU/ NA, Mass Retail and increasingly Drugstores, Make-up, Blades & Razors). The result is an extremely uneven revenue growth performance that is mostly explained by country/ category/ channel footprint.
Again, category/ country couples that have passed the e-commerce cliff in developed markets (e-commerce accounting for more than >100% share of growth of the market – which is now the case of Beauty in NA and in some EU countries and also the case of B&R in many geographies) should see now the largest incumbents on those couples diluting rapidly their market share as a result of falling barriers-to-entry and sometimes deflation (cf. under-performance of largest players detailed in the below chart on US Beauty). That is what drives mostly this extremely uneven growth distribution across BPC companies but also within each company.
Looking ahead, this is an extremely dangerous situation for BPC companies. Some assets will be increasingly difficult to turnaround while being publicly listed (e.g. Revlon but not only). The assets that are still over-performing for now should really use this time to future-proof their competitive positions and address the accelerating structural decline in developed markets and reduce their dependency on a small number of ‘growth engines’
9) Beauty US: incumbents severely hit first and foremost by the channel shift (and in a lesser extent by the category shift)
The latest victim of the channel shift is US Beauty. In a context where Beauty specialist retailers keep growing (Ulta) and where grocery retailers in the US have been recording strong results (Target, Walmart), the decline of most large Beauty incumbents in the US cannot be simply explained by the category shift (strong acceleration on skincare, brutal deceleration on make-up). The key driver is first and foremost the accelerating channel shift diluting now rapidly the market share of the largest players to the benefit of digital new entrants. If BPC is comprised of very involving categories for consumers, its barriers-to-entry are now some of the lowest in the entire FMCG industry (if we except Beauty Luxury).
10) A growth acceleration mostly driven by unit revenue gains hiding for most a large structural profit erosion. P&G performance remains remarkable
The challenge on Household is not revenue growth. The global market is growing at a healthy mid-single digit. Channel shift is still extremely limited (low e-commerce weight, unfavorable unit economics, path-to-purchase pegged to the grocery basket) and private labels (PLs) are yet to gain shares across all categories (e.g. Laundry – unless Paper) as PLs are constrained by the top brands’ promotional intensity. Challenge is and will increasingly be profit in a context of increasing cost of doing business: specifically the amount of ATL/ BTL required to fuel the category and the accelerating trade spend inflation.
In this context, H1 2019 saw a dramatic acceleration in revenue growth mostly driven by an unprecedented increase in unit revenue gains (+200 bps on average – for companies reporting unit revenue gains – ie. excl. Kao and Ontex) mostly driven by a ‘constructive competitive environment’ (promotional spend scale-back). Without those unprecedented unit revenue gains (some being one-off, some being structural like mix gains related to unidose) , profit on average would have dropped by 150 bps: testimony of the ever increasing cost of doing business across the entire vertical.
H1 2019 really marked a turning point on the vertical with for the first time a decorrelation between unit revenue gains and profitability improvement (cf. point 3 of the chart below). The overall suggests that an accelerating erosion of the structural profitability on most of the Household categories is a likely scenario.
In this context, the best short-term answer remains innovating at scale within the product and existing business model. At this game, P&G has been the best over the last few quarters not only on Fabric & Home Care (Unstopable, Unidose) but also on Baby (Pure) and Feminine Care. Once the ‘e-commerce cliff’ hits the category (mostly by ~2023 in NA/ EU), we will notice the accelerating demise of ‘#2 and beyond brands’ as private labels will rapidly proliferate and transfer of profitability to retailers accelerate. In preparation of this likely scenario, the only way forward remains to assemble as of now large DTC businesses addressing key unmet consumer needs.
11) CHC: The vertical displaying the largest growth gap as OTC is increasingly hit by the channel shift
The numbers could have been worse as we could have retained only OTC for RB for example (-5% over H1 2019 partially offset by +4% on infant milk for a net -1%) and as it was impossible to retrieve the electric toothbrush business of P&G from its Healthcare division to really isolate its OTC business.
Our views on the CHC vertical remains the same that we laid out in the below article we wrote 18 months ago: e-commerce cliff, market share dilution and deflation are the key drivers of this under-performance that mostly concerns the least differentiated (or the most ‘molecule driven’) segments of CHC (analgesics, vitamins…) and all call for a structural change in strategy.
12) Bringing it all together
Again if H1 2019 has been a great vintage on average for the FMCG industry, many question marks remain on the sustainability of this performance.
If most FMCG companies managed to shift successfully their focus from profit to present-forward growth over the last 36 months (basically capturing current growth across segments/ channels/ countries), the next frontier is now future-proof growth (growing today while renewing competitive advantages to win tomorrow).
In those times of unprecedented changes, outperforming FMCG companies will be led by CEOs that will display humility and a sense of urgency. Exciting times.
‘The greatest danger in times of turbulence is not the turbulence; it is to act with yesterday’s logic’ – Peter Drucker
Frederic, Nick, Bart, Trip, Akhil & Romy
To continue this conversation, we will host an Exclusive FMCG Senior Executive round-table on January 17th 2020 in our Zurich office from 11 am to 4 pm (lunch will be served), The theme will be: ‘This is the future of the FMCG industry – key predictions for 2020-25 and key strategies per FMCG verticals’. It will be our unique conference in 2020. As usual, the attendance is strictly limited to 12 Senior C-level FMCG leaders (P&L responsibility > $1bn or Group Head of Strategy). Please contact firstname.lastname@example.org to RSVP
Frederic Fernandez does not own any stocks or financial instruments of any FMCG companies or companies mentioned in the above article. All the above information are public information.
About the author:
Frederic Fernandez is an expert and thought leader in the FMCG industry. He is the Managing Director and Partner of Frederic Fernandez & Associates a global bespoke Strategy Consulting Firm exclusively focused on the FMCG industry. Its purpose is to co-create the future of the FMCG industry, one client at a time. The Firm helps the CEOs and the Boards of the world’s largest FMCG companies on selected areas: Growth and Profit turnaround, Exponential Growth strategy (New Retail, Omnichannel, DTC, Ecommerce, Business Model Innovation), Disruption Hedging/Leapfrog and M&A strategy. The Firm’s head office is located in Zurich, Switzerland. The Firm’s team intervenes all across the globe. To know more about the Firm, please visit its website: www.fredericfernandezassociates.com