Is the Consumer Cracking?

by Brad Tank, Chief Investment Officer—Fixed Income, Kristin Cejda, Senior Research Analyst, Jennifer Haidu, CFA, Senior Research Analyst, Neuberger Berman

News from the consumer sector reveals intriguing trends, as well as the importance of credit and security selection in today’s complex market environment.

“Would you like chips and a drink with that?”

For now, most U.S. consumers are saying yes—even if it costs them noticeably more than it did a year ago. Evidently, the idea that consumers will stop spending due to prolonged inflation is too generalized.

Here, we’re going to look at some of the data and statements put out by U.S. consumer companies during first-quarter earnings season. One thing they teach us is that consumption trends are very category-specific.

There is the continued post-pandemic shift from home-based and electronic goods to categories like beauty, pet care and footwear, for example. And with regard to inflation, specifically, we see consumers retaining an appetite to buy at today’s higher prices in categories where brands matter, like soft and alcoholic drinks, medicines, certain beloved snacks and select status-symbol apparel items.

Companies who sell these types of goods have proven that they can pass through price increases with minimal volume impact, supporting margin recovery and outperforming those who sell in more commoditized and discretionary categories.

But is this sustainable?

Paying Up for Pepsi

Volumes have softened in some branded, staple products, but in general, elasticity has been better than feared.

Data from consumer trends researcher Nielsen shows private label, “supermarket brand” options in the more commoditized categories such as bottled water and cereal regaining market share lost to branded equivalents during the pandemic, but further trade-down has not been widespread.

Indeed, Haleon, a manufacturer of consumer health products, noted that it had seen private label actually lose market share over the past three months, and attributed this to the “stickiness” in its product category, where it owns brands like Advil and Tums.

Both Pepsi and Coke—two other winners in the sector—reported gross margin expansion driven by 16% and 11% price increases, respectively. Notably, the volume impact was muted, with Pepsi’s organic volumes down 2% and Coke’s unit case volumes up 3%.

Similarly, continued investment and innovation has enabled a company like Procter & Gamble to raise prices by 10% while only giving up 3% in volume, and even that dip in volume marked a slowing after the previous quarter’s drop of 6%.

Value Hunting

That said, consumer behavior is changing, and channel shifts are occurring.

For example, Amazon has noted a moderation in discretionary spending. We already heard from Walmart earlier in the year about how higher-income consumers were increasingly visiting its stores. Similarly, McDonald’s, as an affordable dining option, reported guest count up in every segment and market share improving across all income groups in the U.S.

Kraft Heinz noted channel migration and an increased awareness around package sizes. Molson Coors also noted a shift away from mid-sized packs to single and larger packs, with the higher-income cohort specifically shifting to the larger packs.

This value hunting should ring alarm bells. Channel-shift and rising package-size awareness are likely the precursor to a trade-down.

Cracks Emerging

Cracks were starting to emerge as the first quarter ended in March and April, coinciding with the outbreak of volatility in the banking sector and the attendant worries about the impact of tightening lending standards on the economy, jobs and consumer spending.

While many companies beat analysts’ top- and bottom-line estimates in their latest earnings reports, increases in guidance were not as widespread, reflecting the uncertainty looming over the remainder of the year.

For example, Starbucks posted better-than-expected first-quarter results as customers maintained their spending on specialty coffee drinks—an affordable luxury—but its stock was down on disappointment that it affirmed but chose not to raise its full-year guidance. In the food and beverage sector, Sysco noted a slowdown in restaurant industry traffic beginning in March and persisting into April. In apparel, both Carter’s and HanesBrands discussed a marked consumer pullback in March that carried into April.

Given this early commentary, earnings are likely to be more volatile in the second quarter than they were in the first.

Idiosyncratic Risk

We’ll finish with a word from the CEO of Kellogg’s. Steve Cahillane described the U.S. consumer as “stubbornly resilient,” and we heard that sentiment echoed across the consumer sector during this earnings season.

But this resilience has been buoyed by the pandemic-era savings cushion, the tight jobs market and strong wage growth. Those savings are now dwindling, and the employment and wage landscape warrants monitoring. As tighter credit conditions begin to bite into the economy and the jobs market, and ultimately into household budgets, we think this resilience will be tested.

These bottom-up observations from within some of the biggest consumer companies in the U.S. reinforce one of our major current investment themes: the rise of idiosyncratic risk across most industries and markets.

We have focused on the consumer sector here, but we see similar patterns everywhere. The impact of the current global economic slowdown will remain uneven, with surprises along the way—in part because of the many and varied ways that nominal price changes continue to unfold.

The bottom line is that credit and security selection remain paramount.

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