As big economies start to re-open more meaningfully, the gap between rising demand and struggling supply is driving consumer prices higher. Anthony Okolie speaks to Juliana Faircloth, Global Consumer Staples Analyst, TD Asset Management, about food inflation and the implications for markets.
- Juliana, there's been a lot of talk about inflation, and I'm sure some of our viewers have started to see price increases creep into the grocery bill. Can you provide some backdrop of what's happening?
- Absolutely. So there's a lot of moving parts, but I think it really boils down to a supply and demand imbalance. So as big economies like the US begin to reopen more meaningfully, we're seeing a huge level of demand from consumers for all sorts of goods. So we know the consumer is in a pretty good spot-- they received stimulus payments, they've built up a lot of savings. So overall demand is pretty significant. And that's kind of a mismatch to what's going on the supply side, where global supply chains are still being impacted by COVID-19.
It's hard to find raw materials. It's hard to find labor. So manufacturers are seeing shortages in all sorts of goods, from semiconductor chips all the way to things like vanilla extract. It's very broad-based. And that supply and demand imbalance is what's really driving prices higher.
So you mentioned that we're starting to see that in our grocery bill, and the big package food and household product companies are seeing inflation on everything from corn and wheat to plastics and aluminum. I've brought a chart today that shows an example of a couple of these raw material inputs for consumer staples companies. And you'll see particularly corn and aluminum are up nearly 50% since last year. So that's quite significant.
So with all these big cost increases, how are companies in the food, beverage, and household care industries managing it?
- It's a great question, and, of course, very important, because this type of inflationary pressure can have a big impact on margins and profitability. So I would say there's sort of two strategies to try and manage that. The first is also on the cost side. Companies in this space are very focused on squeezing out efficiencies in the other parts of their cost structure, so marketing and sales functions, for example. And then, of course, the other option is to pass some of that through to consumers through pricing, and that's what we're starting to see.
And of course, we know that consumers don't always react well with price increases. So how are these companies planning to raise prices without impacting consumer demand?
- You're absolutely right. I think particularly for consumer staples, where there's a lot of different brands, there's private label options, there's a number of substitutes, price increases have not always gone smoothly. Sometimes it starts to impact the overall volumes that a company is able to sell. And it can also damage relationships with retailers who are ultimately the ones that control the shelf space.
I would say, however, that the sector is in a bit of a better position this time around versus prior commodity cycles. And there's really three reasons for that. The first is that staples companies have developed much more effective and discrete pricing strategies. So they've spent a lot of time building out enhanced data and analytics, better product innovation, better packaging innovation, all to try and minimize the amount of direct list prices that they need to take. So when you notice that there's fewer chips in your favorite bag of chips, that's part of the pricing strategy.
The second reason is I think the relationship between these consumer packaged goods companies and retailers has been strengthened throughout COVID. In the past, companies have hesitated to push through pricing increases for fear that a company like Walmart is going to perhaps cut their shelf space in half. But what we've seen is that throughout the crisis these companies built up a lot of goodwill with retailers, being better able to maintain their supply chain and keep shelves stocked, and that's created a much more positive environment for pricing conversations.
And the last reason would be just the pure strength of the consumer. So of course no one likes to see the price of goods moving higher, but consumers broadly are in a stronger position to absorb price increases, just with the level of stimulus and savings that have been built up.
And when we talk about inflation, certainly there's a debate whether it's going to be transitory or it's going to be here much longer. How long should we expect this inflationary pressure to last?
- I would say it's a bit early to tell. Most signs are pointing to this being a temporary phenomenon, as you mentioned, as we expect demand to probably ease up as things normalize and as supply chains can kind of get back up to their full strength once we move past the pandemic. That being said, it's certainly something we're watching closely. Within the consumer staples sector specifically, it's probably one of the biggest downside risks to earnings for the next year.
So what should investors be thinking about when investing in this space?
- Sure. So inflation is one big consideration. But I think the sector is sort of facing a few headwinds. Most of the companies in the space are experiencing decelerating sales and earnings growth as we start to move past the one year mark, past consumers stockpiling and hoarding goods in their pantries. The other sort of challenge is just the general market tilt away from defensive sectors like consumer staples and focusing more on sectors that are a bit more economically sensitive in the face of the recovery that we're seeing.
From an inflation perspective, I would say it's become increasingly important for staples investors to think about pricing power. We want to invest in companies that have a more consistent ability to push through pricing without impacting the volumes that they sell. I think historically some companies that have been better off in that type of environment are in the beverage space, so a company like Pepsi or Coke, or companies with relatively more premium product positioning. So Estée Lauder would be an example there.
- Juliana, thank you very much for your insights.
- Thank you so much.