As a follow up to our previous Q&A with Neil Abbott, Senior Portfolio Manager, RBC Global Asset Management (UK) Limited, we take a look at what drives competitive advantage in a sector which features everything from soft drinks, to auto parts, to leisurewear. We also touch on how the sector has been impacted by recent macro events, during a challenging few years.
There are many companies jostling for position in the consumer sector. Obviously your research is detailed, but can you highlight how you know a company has something special to offer?
Competitive advantages can vary by industry, and some of them are very obvious. A company’s brand is probably the most important part of any consumer assessment, and some companies, such as Coke, Tesla and Disney, obviously have very powerful brands. Brands are intangible drivers of long-term value creation and rarely feature on balance sheets or in the cash flows of companies, but they are the starting point when thinking about consumer investments. As part of our analysis, we ask: ‘What do consumers identify with? Do they trust the brands that they're spending their money on?’
Brands are the first thing we look at, but technology also plays an important role. Companies such as Amazon, Ocado and Tesla are technology-driven consumer companies. Their technology is industry leading and gives them a sustainable competitive advantage, and that is important for us when we do our research and make long-term assessments.
What else is important when looking for the proverbial jewels in the crown?
For any consumer company, distribution capability is important i.e. how goods reach consumers. Obviously, Amazon changed the world in that regard and to be able to buy more or less anything at short notice is a fantastic capability and one that we like from a competitive perspective, however it’s not the only way to have a distribution advantage. An example is Unilever’s Indian subsidiary which reaches approximately 1.4 billion people, and which no e-commerce or traditional consumer company in that country can match.
Some companies in the U.S. use a ‘Direct Store Delivery’ system where products go directly from production plants to retail stores. These companies have direct relationships with the retailers, and this enables them to interact with consumers. Not all big FMCG – or fast-moving consumer goods companies – do this, and many distribute through third parties. However, the companies that do use this approach can have a strong distribution advantage.
We also look at the more intangible aspects of a company, such as the people and culture and in recent years, sustainability. This is an important aspect of consumer companies as it has given rise to the concept of brands with purpose. We believe this is an extremely important way of gaining a competitive advantage.
Companies with an innovative culture can also have a winning edge. A Brazilian beer company, for example, would be managed differently to a traditional British or American beer business, and the Brazilian culture and energy and excitement around that can make an ‘old’ – or traditional – business seem like a young business. Understanding that culture and the way it can impact a company is part of understanding its competitive advantage.
Finally, we seek management teams we can trust, and that takes time which makes it challenging for us to be nimble when it comes to investing. Ultimately though, we assess companies’ management teams constantly, as part of our ongoing due diligence, so we rarely have to start from the beginning. We believe that an example of a company with strong management is Home Depot, which is a very mature business, and which we view as being well managed in that it seeks to keep consumers happy, and treat its employees and shareholders fairly.
Speaking of management focusing on customers and shareholders, what are your views on engagement?
Thinking like an owner is the key point here. We spoke to the CEO of a U.S. retailer who, during the pandemic, sought to ensure that none of his employees would lose their jobs and committed significant sums to making sure that his employees could take time off, if needed. In the short term, these actions could impact quarterly results, whereas in the long term, we can see this as a company building strong contingent assets and creating value.
As an interesting aside, the retail sector typically has very high turnover levels and staff are generally not committed to their employers. Over time, a few companies have recognised that having experienced staff in-store who can help consumers is a key component of their customer service. Employee turnover levels are much lower at good companies, and especially ones where employees are treated as partners in the business. We always look at turnover levels in a company when we're thinking about investing. The rate of change can give us a signal for something changing positively or negatively in the culture.
Finally, viewed through a consumer lens, how have recent inflationary pressures and interest rate rises played out in the sector and for you, as investors?
In our view, inflation was visible in the consumer sector before other sectors. Towards the end of 2021, it became clear to us that we were going to be seeing quite high levels of inflation coming through from consumer companies. The twin pressures of high inflation pushing up prices, and probable increases in interest rates pushing up mortgage costs, were bad news for consumer companies.
In this type of environment, more consumer spending capacity is allocated to basics, such as food and drink, and the amount left for discretionary spending becomes squeezed, so we had to think about how we would respond to that. We also needed to think about which of the companies we could invest in were best able to deal with inflation, i.e. the companies that would be able to raise their prices to protect their margins, but not see high levels of elasticity in terms of negative demand response.
As we move into 2023, we continue to learn more about consumer companies and industries, as always. In particular, sustainability is high on the agenda and conducting in-depth, annual ESG engagement will be a key focus of our investment activities across this interesting and ever-evolving sector.