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12/15/2016

The View from Wall Street

Deutsche Bank’s Bill Schmitz reveals what drives valuations in consumer goods and analyzes the impact of pivotal market trends, like digital marketing, e-commerce and emerging markets.

Bill Schmitz

CGT: What do investors like about the consumer goods sector right now? On the flip side, what are your concerns about the sector?
Schmitz: Investors have and will continue to like the strong cash generation and predictable and sustainable top-line growth algorithms of the industry. Valuations are typically driven by relative earnings and free cash flow yield of the group relative to prevailing interest rates, with group trading at higher valuations in low and falling rate environments and lower in high and rising interest rate environments.

Biggest concerns are recovering in developing markets, the impact of a strong dollar on sales and earnings, and investor fund flows in a rising rate environment (which often means relative underperformance for consumer products stocks). We at Deutsche Bank have a market perform view on the group, meaning that the stocks should perform roughly in line with the market over the next 12 months.

CGT: Regarding digital marketing, what are consumer goods companies doing well to improve the shopper experience and build consumer relationships?
Schmitz:
Channel shift, especially to channels not tracked by Nielsen, is the biggest topic in the industry right now. The fear is that as new channels grow and develop, brand choice greatly democratizes and the barriers to entry for smaller, niche brands fall.

Digital marketing is a high return endeavor and often discussed, but it has to be part of a holistic marketing campaign with real, consumer-driven innovation, the only sustainable enabler of high marketing ROI. The consumer shops increasingly in an omnichannel world with little loyalty — they are shopping wherever the consumer value equation is best in their view (i.e. value = price + perceived utility). It is not just price alone and includes convenience, shopping experience and price.

CGT: What is the future of e-commerce in consumer goods? How will direct-to-consumer initiatives impact the industry?
Schmitz:
We are just at the tip of the spear in terms of e-commerce, but we believe it will ultimately settle in well above the 5 percent of industry sales many pundits are expecting.

In China, more than 30 percent of diapers and more than 20 percent of shampoo are sold online. While there are subtleties related to the retail landscape in China, we believe most other major markets will catch up, with the UK the biggest developed market in terms of e-commerce penetration. 

Direct-to-consumer is currently confined to a few categories (shaving and cosmetics), but it is growing rapidly and a favored channel for Millennials, something the big, traditional consumer packaged goods manufacturers need to be mindful of to remain relevant.

CGT: What are your thoughts on emerging markets? How can consumer goods companies tap talent to enter and grow in these areas?
Schmitz:
Emerging markets per capita consumption opportunity remains the biggest long-term opportunity for the industry, recent dislocation aside. Middle-class creation, urbanization and female workforce participation are primary drivers, and history tells us consumption in these markets will track personal disposable income growth.

Importantly, leadership in these markets is going through a powerful inflection, with expats replaced by cultivated local talent that understand the cultural differences in doing business in these markets.

To further build out the talent pool, companies need to have a balance of a powerful, in-house training and strong recruiting effort to identify and attract the best talent in the market, including finding strong talent from local and international competitors and companies outside the industry.

CGT:Which segments have the highest growth potential?
Schmitz: I remain bullish on the cosmetics industry given expandable consumption, leverage to millennial shoppers and, increasingly, growing ranks of woman in the white collar and services workforce.

As mentioned above, we are also extremely sanguine about e-commerce and how it reshapes the industry, but still believe the biggest incumbents have a lot of catching up to do.