Tuesday 19 June 2012

Yogurts, European Consumer Confidence and Consumption

"Consumption may be regarded as negative production."
Alfred Marshall - Economist

Looking at European company Danone's profitability warning leading to a drop in the share price in conjunction with a dismal German investor confidence Zew index (ZEW institute reported that its monthly confidence index dropped by 27.7 points to a level of -16.9 points — its strongest decline since October 1998) has made us reflexionate around Yogurts, European Confidence level and Consumption.
Danone share price taking a beating - source Bloomberg:

As reported by Dermot Doherty in Bloomberg, Danone, the world's biggest yogurt maker cut its profitability forecast as Spanish consumers switch to less expensive products and raw-material costs rise, sending the shares down the most in three years - Danone Cuts Profitability Goal on Southern Europe, Costs:
"Danone is losing market share in dairy in Spain, where about one in four people are unemployed, and will take measures such as cutting costs and introducing new products to react. That will reduce profitability in southern Europe, Chief Financial Officer Pierre-Andre Terisse said today.
“The competitive environment in Spain is a lot tougher, so they’re having to invest more in promotion and pricing,” said Martin Dolan, head of equity research at Espirito Santo in London. “This is very Danone-specific rather than sector wide because of milk raw-material costs, and Danone’s exposure to Spain is far greater at about 8 percent than for other big food companies.”

Danone also indicated in relation to consumer spending in the same article:
"The French yogurt maker in April said it expected consumer spending to remain “under pressure” this year in western Europe. European companies are wrestling with the fallout from a drop in consumer spending as the sovereign debt crisis rocks the region’s economies. Carrefour SA, the biggest European retailer, last week said it would withdraw from Greece and carmaker Fiat SpA said it would cut investment in the region by 500 million euros ($630 million)."

In similar fashion to the trend in shipping with shipping giant Maersk is in fact shifting its business away from Europe (Shipping is a leading deflationary indicator) while Airlines are benefiting from growth outside Europe where traffic to the Americas have been the biggest beneficiary (Air Traffic is a leading deflationary indicator), Danone said sales growth target of 5-7% was unchanged; with robust performance in Asia, Americas, Africa, Middle-East, CIS offsetting pressure in Western Europe.

Leading us to an interesting exercise, plotting Danone share price against the gauge for consumer sentiment which last came at minus 19.3 (from minus 19.9) at the end of May 2012: Danone share price versus European Consumer Confidence since 2006 - source Bloomberg:
At the end of May Consumer Confidence in Europe fell to a two and half year low, following the previous inconclusive Greek elections, Spanish woes and fears of a euro break up.
Yogurts matter as an indicator? One has to wonder...
As austerity bites consumer spending and with Italy and Spain in recession, companies have been forced to lower cost to protect earnings so far. End of May the ECB also indicated that loans to households and companies in the euro zone grew at the slowest pace in two years as the on-going crisis curbed demand for credit.

We already discussed the difference between the growth differential between the USA and Europe (Growth divergence between US and Europe? It's the credit conditions stupid...), which continue to improve in the USA for now as indicated by my friends at Rcube Global Macro Research:
"The private sector credit growth (one of the most reliable Fed Fund leading indicator) has spiked(15% yoy).
The % of US commercial banks reporting stronger commercial & industrial loan demand is back to 2004 levels."
"As a result, US commercial banks will adjust balance sheets to the rising demand for loans, buying fewer Treasuries in the process. Their stock of government securities has risen from less than 10% of total assets in Q4 2009, to 15% today. While the incentive to do so was large over the last 4 years (extremely steep yield curve, falling inflation, broken credit channel), it is less so today. Their pace of purchase has already slowed from 25% YoY in Q3 2009 to less than 10% today, and should weaken further."
- source Rcube Global Macro Research - 18th of June 2012

As far as European Staples are concerned, according to a recent study by Morgan Stanley, impact of private consumption in Europe could be very significant in "European divorce" scenario playing out  - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012:
"Better prepared for an even worse scenario? In a “European divorce” scenario, the impact on private consumption in Europe could be worse than in 2009 due to the reduced scope for fiscal and monetary policy and higher unemployment. On the positive side, the Consumer Staples sector could see less of a relative de-rating because a) financial leverage is lower, b)inventory levels are generally at more manageable levels, c) commodity inflation is lower, and d) many companies have also expanded their lower-price point offerings. The relative re-rating has also been more measured this time, as the PE premium (60%) has not yet reached the peak from Nov 2009 (80%)."

It isn't only Danone facing similar exposure to weakening consumption levels in Western Europe with a slowdown in consumption levels in peripheral countries such as Spain. Heineken, L'Oreal, Reckitt and others are also exposed to similar trends as indicated by Morgan Stanley in their recent note:
"Within the region, Southern Europe only accounts for less than 10% of group sales on average across the sector. Imperial Tobacco is the most exposed to the region (Spain accounts for around 2/3 of its sales in Southern Western Europe). It is followed by Diageo and Heineken with more than 15% of group sales in the region (mostly Ireland and Spain for Diageo, and mainly Spain and Italy for Heineken). In Food, Danone has the largest exposure to Southern Europe, as Spain (~14% of group EBIT) is its most profitable market." - source Morgan Stanley - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012

No surprise Morgan Stanley's conclusion:
"Mix is Key
Our Bear case analysis illustrates the importance of having diversified portfolios and geographic exposures. Geographic mix (which we define as higher-margin regions growing faster than the group average and vice versa for lower-margin regions) plays a crucial role in determining the magnitude of downside risk in our Bear case scenarios."

In regards to European Consumption trends, CreditSights in their recent Euro Consumer Takeaways from the 18th of June made the following interesting points:
"-Italy: Confidence has fallen to its lowest level ever as of May; minus 38.6. Spending had already fallen by 2.4% in the 12 months to the first quarter, which is as large as the fall in the 2009 recession. Consumer spending can only fall so far before households fall back on subsistence levels, and prolonged declines in spending are rare. As such they believe that full-year spending decline will be less negative than the 2.4% fall in the year to the first quarter, but we are still expecting to be at least 1% lower over 2012 as a whole in real terms.
-Households debts in France, Germany and Italy are much lower versus national income; compared to the UK (96% down from 103% of GDP in 2009); respectively 55%, 60% and 45% of those country’s annual GDP. Household debt-to-GDP for the Eurozone as a whole is 65%. But while households in France, Germany and Italy are less encumbered by debts and do not, therefore, have to divert income to servicing that debt, low interest rates should still act as some motivation to bring forward spending by borrowing. They believe that is especially the case of borrowing costs are barely any more than households expect their salaries to grow by.
-Consumer borrowing costs , adjusted for wages, in Germany are roughly in line with the crisis low in 2007 at 2%. However, at 4% in France and 6% in Italy, the interest rates on unsecured debts are well above the lowest rates they reached in the 2000s. Additionally, these lower real borrowing costs have not obviously generated greater increases in household debts.

Wealth holdings – the “housing” conundrum:
"In the UK most peoples’ primary provisioning for retirement is their house, that tends to mean that changes in house prices are closely associated with changes in spending. Therefore the stabilisation in UK house prices is good in that falls are not actively undermining spending any more, but in their view it will be a long time before rampant house price appreciation once again drives a boom in consumer spending.
In Germany and France, house prices have, since 2009, been growing strongly. Prices were not over-inflated by a bubble in mortgage lending in the pre-recession years. And to some extent that growth may feed through to a greater willingness to spend in those countries. But their UK contemporaries and so while booming prices in Germany may provide some inclination to spend less, they believe that more consistent income growth and falling unemployment (leading to greater job security and consumer confidence) will be more important drivers of any increases in household spending.
In contrast to France and Germany, Italian house prices have been falling for some time. And falling incomes, tax-induced increases in prices, rising unemployment and worries about the government’s fiscal position are all likely to ensure that spending by Italian households remain depressed with or without the additional impact of house price declines."

UK wise:
"The government’s attempt to tighten its belts at the same time as the private sector is also cutting spending will not only be self-defeating for the government’s fiscal position but is prolonging the period that it takes UK consumers to reduces their debts and feel confident once again about the outlook for their incomes. They expect UK household spending to be centered around the 0% range this year."

With consumer confidence and investor confidence in the doldrums, in conjunction with struggling Southern Europe no wonder yogurts are taking a beating...

"The shelf life of the average trade book is somewhere between milk and yogurt."
Calvin Trillin

Stay tuned!

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