Investors have been trying to assess which companies and categories will show the best volume resilience to record pricing. As the end of free money creates a world in which cash is king, there are potentially profound consequences for the sector.
A combination of higher interest rates and double-digit food inflation is severely squeezing disposable income and changing buying patterns – but it also has the potential to change companies’ capital allocation priorities.
A higher-for-longer interest rate cycle is a risk to earnings forecasts, as companies are exposed both via floating debt and the need to refinance fixed debt. Conversely, some companies should enjoy an earnings benefit from rising interest rates, either because they have net cash or, more unusually and somewhat counter-intuitively, because their debt is fixed but they have large and floating cash positions. Higher interest rates may also force some companies to prioritise debt paydown and dividends over share buybacks and acquisitions.
The most leveraged companies in European staples are Ontex, Corbion, Haleon, ABI, and Essity. By contrast, Fever-Tree, Beiersdorf, and AG Barr all have meaningful net cash. However, to understand risk, one needs to look at how much of both debt and cash is fixed vs floating, and whether there are any near-term refinancing needs. The next step would be to stress-test earnings for different interest rate scenarios.
The other big impact we see is elevated valuation multiples for acquisitions coming down in line with listed company valuations. This is good news for companies with strong balance sheets and ‘dry powder’ – not least because much higher funding costs for private equity players make it difficult for deal maths to work.
Less competition from private equity is a likely outcome, and as such we expect an increase in deal activity from large listed players, with bigger ticket deals possible. Nivea owner Beiersdorf has 20% of its market capitalisation in net cash equivalent to €5bn. It has recently started acquiring companies, including US suncare business Coppertone and US prestige beauty brand Chantecaille. Even if it doesn’t do more deals, its cashpile becomes more valuable in a rising rates environment.
Whilst a higher interest rate environment might make acquisitions potentially easier (and likely cheaper), the other side of the coin is that it could make disposals harder and at lower valuations. This is important because portfolio rotation has been an important driver of value creation at many consumer staples companies in recent years.
Less attractive, lower-growth assets have been disposed of, often to private equity (Unilever’s spreads and tea businesses, Reckitt’s sale of Chinese infant formula, Nestlé North America’s water business, and Danone’s Vega plant-based brand to name a few). The proceeds have been used for acquisitions in faster-growing categories with greater consumer relevance.
Nestlé has rotated more than 20% of its portfolio since Mark Schneider became CEO in 2017. The message is that most of its disposals have been done, and the company is now more focused on acquisitions. It is in the middle of a CHF20bn buyback programme, but has reserved the right to pause buyback in the event of a strategic acquisition. Some gaps in its portfolio include Asian petfood, consumer health, and super-premium chocolate.
Unilever, by contrast, offered £50bn for GlaxoSmithKline’s consumer arm (now Haleon) in January. With activist Nelson Peltz now on the board, we expect it to be more circumspect with regards to M&A – although it still has an ambition to treble its revenues in prestige beauty and functional nutrition. Meanwhile, Danone has a new CEO and has said 25% of its portfolio is ‘underperforming’ – therefore it’s likely to be more in disposal mode.
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