TheChek News Flow

Shoppers cut spending or turn to own-brand goods as inflation surges into double digits

The two largest makers of consumer goods have been hit by shoppers around the world tightening their budgets and turning to supermarkets’ own-brand products, with Nestlé warning that prices would have to rise further.

Sales volumes at Switzerland’s Nestlé and US-based Procter & Gamble fell in the third quarter as inflation continued to surge and consumers’ tolerance for steep price increases began to crack.

Mark Schneider, chief executive of Nestlé, warned of further price increases ahead as energy and labour costs mount over the next few months. “Obviously some of the pricing will have to continue [rising] . . . our pricing is still catching up with the hit we have taken from inflation,” he said.

P&G, which generates more than half of its revenue outside the US, is also suffering from a strong dollar. Andre Schulten, its chief financial officer, said on Wednesday: “We fully expect more volatility in costs, currencies and consumer dynamics as we move through the fiscal year.”

Price rises led by food are straining consumer budgets globally: Europe especially has been affected by the war in Ukraine and the resulting energy crisis. Eurozone inflation topped 10 per cent in the year to September, while UK inflation is also in double digits.

Schulten said: “We see high pressure on the European consumer, with high inflation and, certainly . . . energy costs will hit the consumer over the winter period.”

Makers of global brands have so far fared better than expected as inflation has soared, but the squeeze has begun pushing more consumers towards cheaper products and own-brands. Companies’ margins are also coming under pressure as they race to push through higher costs.

P&G raised prices by 9 per cent year-on-year across its product lines in the quarter to September, while Nestlé pushed through a 7.5 per cent year-on-year rise in the first nine months of 2022, its biggest in decades.

But P&G’s sales volumes still declined 3 per cent in the quarter, while Nestle’s real internal growth — a measure of sales volumes and consumers’ product choices — slid 0.2 per cent in the third quarter, according to analysis of its nine-month figures. That figure was lower than analysts expected. Supply chain problems also played a part, the company said.

Nestlé’s like-for-like net sales growth reached 8.5 per cent in the first nine months, its highest rate in 14 years, propelled by the price increases. The maker of Maggi noodles, Kit Kats and Nespresso coffee capsules said it expected full-year sales growth of 8 per cent, the higher end of the range it had previously signalled.

P&G, which makes Tide detergent and Tampax tampons, expects its sales volumes to fall 1 to 3 per cent in its fiscal year, down from its previous forecast for flat to 2 per cent growth.

P&G also forecast a $1.3bn hit from the strong dollar this fiscal year, or a 6 per cent knock to its sales growth, $400mn more than originally anticipated.

The US-based group declined to say whether it would raise prices further, but acknowledged limits to its pricing power, particularly in Europe.

James Edwardes Jones, an analyst at RBC Capital Markets, said Nestlé was “coping admirably” but noted that sales of its bottled water, prepared foods and confectionery had slowed in the third quarter. “Even Nestlé, it could be argued, is starting to show early signs of tougher conditions,” he added.

Schneider said pressure on consumer wallets was coinciding with a return to more normal shopping patterns following the acute phase of the pandemic. “You see a bit of trading down” but some of the shifts were down to “post-Covid normalisation”, he added.

Shares in Nestlé fell 1.28 per cent on Wednesday to SFr106.40, while shares in P&G rose 1.8 per cent to $130.79 after its results surpassed analysts’ expectations.

Pension funds accuse German carmaker of failing to disclose details of lobbying via trade associations

Volkswagen faces possible legal action by a coalition of institutional investors that accuse the German carmaker of having refused requests to answer questions about its lobbying activities related to climate change.

Five Swedish and Danish public pension funds and the Church of England Pensions Board said they were concerned that while VW was “publicly championing the green transition”, it may be lobbying against stricter climate rules.

Such a contradiction would expose the company to reputational and operational damage, they added.

It is one of the first times institutional investors have contemplated litigation on a climate-related matter in Europe. The investors attempted to include climate lobbying as an agenda item at VW’s 2022 shareholder meeting but this was vetoed by the company’s management.

VW’s stance on the environment has been a sensitive issue since the Dieselgate scandal broke in 2015 when several of VW’s brands, including Audi and Porsche, were found to have used software that deceived regulators over harmful emissions.

The carmaker is in the middle of a transition to electric vehicles — a costly process that is expected to have significant ramifications for the companies in its supply chain.

Adam Matthews, chief responsible investment officer at the Church of England Pensions Board, said it was “extremely disappointing to have to turn to the courts to get VW to do the right thing”.

“VW is failing to demonstrate that the lobbying undertaken and funded by the company through its industry association memberships is aligned to its own climate goals,” said Matthews.

VW said that while it shared the shareholders’ view that “aspects relevant to climate protection deserve an even higher priority in reporting”, it disputed claims the company had been legally wrong to dismiss their request to add items to its annual meeting agenda.

The German automaker, which sells roughly 10mn cars a year, said the “distinction between the legal and substantive assessment is important”.

It added that it was “currently considering” ways to strengthen the “extensive transparency measures that we have already implemented”. 

The shareholders pressing action collectively own roughly 0.1 per cent of VW’s shares, equivalent to a market value of around €62.3mn. But a court’s decision would be legally binding and would set a precedent.

Emma Henningsson, head of responsible ownership at the Swedish pension fund AP7, said the court case would clarify whether shareholders had a right to put an item on the agenda of an annual meeting, a grey area in German corporate law.

Other corporate governance issues such as diversity and inclusion, discrimination or conflicts of interest could then also be put forward for shareholder votes if the court case succeeded, according to AP7.

“Success would mean that more shareholders could contribute to improving the governance of the company. A ruling in favour of investors would improve corporate accountability and transparency for shareholders in other German companies,” said Henningsson.

The Amazon founder is the latest corporate leader to warn on the economy as growth and hiring have slowed

Jeff Bezos said the economy is flashing warning signs, joining other corporate leaders who have cautioned that the U.S. is headed for a recession.

The Amazon.com Inc. founder suggested that people should get ready for a potential economic downturn. His comment came in response to a video clip from Goldman Sachs Group Inc. Chief Executive David Solomon, who said companies should be cautious and prepared in the event the U.S. enters a recession.

“Yep, the probabilities in this economy tell you to batten down the hatches,” Mr. Bezos said in a tweet Tuesday night.

Mr. Bezos is the world’s second richest person with a net worth of $139 billion, according to the Bloomberg Billionaires Index. He stepped down from his role as the chief executive of Amazon last year and is now the company’s executive chairman.

His comments come as tech firms have undergone waves of layoffs and as economic growth and hiring have slowed. A recent survey of economists by The Wall Street Journal also found that they expect the U.S. to enter a recession in the coming 12 months as the Federal Reserve raises interest rates and attempts to cool stubbornly high inflation.

The views of other business executives have also become increasingly gloomy.

Mr. Solomon said in a CNBC interview Tuesday that a recession could happen soon, and there may be “more volatility on the horizon.”

“That doesn’t mean for sure that we have a really difficult economic scenario,” Mr. Solomon said. “But on the distribution of outcomes, there’s a good chance that we have a recession in the United States.”

JPMorgan Chase & Co. Chief Executive Jamie Dimon also said earlier this month he thinks the U.S. is heading for recession in the middle of next year.

Tesla Inc. Chief Executive Elon Musk said in August he expects the U.S. to have a mild recession.

Bank of America Corp. Chief Executive Brian Moynihan is one notable optimistic voice among corporate executives.

Mr. Moynihan said Monday that high inflation and rising interest rates haven’t slowed down American consumers. The company’s data show that spending growth remains strong and deposit balances remain higher than prepandemic levels while delinquencies remain low, he said.

Many companies also say they are still having a hard time with large staffing shortages that accumulated during the pandemic and are reluctant to reduce their payrolls. Many are still hiring.

Some notable tech firms, however, have put the brakes on hiring or have begun laying off staff.

Amazon went on a hiring spree during the pandemic to keep up with customer demand. But Amazon’s Chief Executive Andy Jassy said the company will be slowing down hiring in the near future.

Microsoft Corp. laid off more employees this week. Peloton Interactive Inc. said earlier this month it would slash about 500 jobs, roughly 12% of its remaining workforce, marking the company’s fourth round of layoffs this year.

Facebook owner Meta Platforms Inc. is also cutting back its headcount. Snap Inc. initiated layoffs over the summer.

Twitter Inc., Netflix Inc. and Uber Technologies Inc. have also been either cutting back on staff, reducing the size of some teams or freezing hiring.

Four previous housing downturns have ominously familiar elements to today’s situation — so what can we learn from the past?

At the end of August I thought the housing market was looking scary; in recent weeks, it has looked terrifying.

A downturn isn’t guaranteed by any means and there is some hope — following the new chancellor of the exchequer Jeremy Hunt’s decision to reverse most of his predecessor’s turmoil-inducing “mini” Budget — that mortgage rates will start to come down. But, looking at previous housing crashes, it has to be said: a lot of the elements are in place.

There have been four significant housing market downturns in the UK in the past 50 years. Each one has been unique and left a mark on those who experienced them — from collapsing transactions to bailouts to repossessions. But there have been some consistent themes: changes in interest rates, rising energy costs and policy mistakes. And it is all starting to sound ominously familiar.

What lessons can we learn from the downturns of the past? Throughout the 1970s, changes in mortgage rates helped drive bubbles and busts in housing, while rising energy costs squeezed household incomes and contributed to recessions. The two downturns in this period (1973-77 and 1979-82) were unusual in that nominal house prices didn’t actually fall. However, high inflation led to large falls in real house prices — and there were certainly real-world consequences. Mortgage repayments soared and transactions slumped.

But if some homeowners managed to ride out the period of high inflation (the Retail Price Index [RPI] reported a record annual rise of 26.9 per cent in August 1975), the rapid depreciation in their mortgage value relative to rising incomes helped create the “housing ladder”, as it meant they could take out bigger loans and trade up very easily.

The early 1990s downturn was, again, caused by interest rates — they were cut following the stock market crash of 1987, then rapidly increased as inflation rose towards the end of the decade. And, as today, there were policy mistakes. In 1988, chancellor Nigel Lawson announced couples could no longer pool tax relief on their mortgage interest, but didn’t wind up the scheme for another six months. The delay allowed a rush of buyers to try to beat the deadline, causing house prices to spike — just before they plunged.

In the 1980s, the mortgage market was much riskier than today. Borrowing at very high loan-to-value (LTV) ratios was common and endowment mortgages (which were interest only) were popular. When interest rates increased, the bubble burst and the downturn was severe. Nominal house prices fell by 20 per cent with real prices hitting a low in 1995 — 37 per cent below their previous peak. Negative equity hit recent buyers, while repossessions spiked and developers rushed to exit the market, many of whom never returned.

The downturn lasted so long because of the limited government support. While interest rates were quickly lowered, and there was help in late 1991 to reduce the number of repossessions, it wasn’t until November 1992 that a “housing market package” was produced — which mostly focused on funding housing associations to buy homes from forced sales.

When the next downturn hit some 15 years later, policymakers were quicker to respond. Following the financial crisis of 2008, the Bank of England made big cuts to interest rates, from 5 per cent to 0.5 per cent, immediately easing the pressure on household finances for those on variable rates — and arguably delaying the pain until, well, right now. Repossessions still increased but lenders were more careful to avoid flooding the market.

This is not a housing bubble bursting per se, it’s an interest rate bubble that’s taking housing — and chunks of the economy — with ibubble that’s taking housing — and large chunks of the economy — with it. That might sound strange given house prices have been at record highs relative to incomes.

But there have been none of the usual signs of strain seen in the late 1980s or mid-2000s: mortgage lending has been much more tightly regulated, finances have been stress tested and no one has been inventing their income with a self-certification mortgage — which, unbelievably, was allowed before 2009.

This all came at a cost: many people have been excluded from home ownership over the past decade by these rules. But the upshot is that recent buyers are probably the safest cohort of borrowers we’ve ever had.

Unfortunately, there is one metric that has risen sharply over the period: the loan-to-income ratio, from 2.8 in 2007 to 3.4 this year (it was 2.1 in 1994). The higher this ratio is, the more dependent borrowers are on low mortgage rates and the more exposed they are to any rises. This means even relatively small increases in interest rates can be as unaffordable — or more — than big jumps were 30 years ago.

Much depends on how high rates stay and for how long. But at current rates, affordability calculations suggest house prices could easily fall by about 20 per cent, a similar rate as the previous two crashes — but drops could be larger in areas more dependent on higher loan-to-value mortgages.

While taking the average property price back to about February 2020 might not sound a great deal, very few would be immune from its effects. Even those owning their home outright would watch their — albeit mostly notional — personal wealth drop. Those with equity release products or treating their “home as a pension” would be more directly affected, as would new first-time buyers who have stretched themselves to buy.

Some groups will need more government support than others. The plight of those in shared-ownership properties — who pay both a mortgage and rent — is particularly worrying, with rising mortgage rates and rents linked to inflation (the RPI hit 12.3 per cent in August); as it is for those who have recently signed up to the government’s Help-to-Buy equity loan scheme. Renters have already had to deal with spiralling prices in the past 18 months, and now face further increases. The need for household support could be enormous.

The challenge with all this support — beyond the state of public finances — is getting the right outcome. Those in the most need will need help immediately, but there could be an opportunity here.

Higher interest rates could help lower house prices relative to incomes — though they are unlikely to return to the levels of most of the 20th century (three times income) and, of course, increasing incomes is a better way to lower that ratio than crashing prices. But if house prices do fall, rather than just letting them reinflate, why not readjust the housing market so that it works for more people? Such as by helping first-time buyers to benefit from the lower values, rather than letting landlord investors or wealthy buyers cash in on lower prices — which is what happened after the last crash.

* Close Brothers Raised to Outperform at KBW; PT 1,150 pence

* Continental Resources Raised to Equal-Weight at Morgan Stanley

* Citi Says US Stocks Pricing Recession More Than Any Other Asset

* Frasers Group Upgraded at RBC on Resilience During a Downturn

* Goldman Overweights Defensives and Shuns Cyclicals in US Stocks

* Just Eat Ebitda Turning Positive is ‘Welcome News:’ Jefferies (+)

* Nestle 3Q Sales Growth Beats on Strong Pricing: Jefferies (+)

* Veolia Risks More Than Priced In, Morgan Stanley Upgrades

Miami-based operator ‘gets creative’ with collateral on 10.75% yield bonds

Carnival, the world’s largest cruise operator, borrowed $2bn through a bond offering that used a dozen of its ships as collateral, as it works to refinance its huge debt pile amassed during the pandemic.

The company was able to borrow more than the $1.25bn it had initially planned to raise and at a lower interest rate than Carnival was prepared to stomach just hours earlier, according to two people briefed on the deal.

The new debt was discounted and priced with a coupon of 10.375 per cent, offering a yield to investors of 10.75 per cent. That was markedly below the 11.5 per cent yield bankers had marketed to credit investors on Tuesday morning, with the company citing “strong investor demand” for the bonds.

The issuance is the company’s first foray into the junk bond market since May, when a 10.5 per cent bond coupon spooked the stock market.

The double-digit coupon underscored the rapid increase in borrowing costs as the Federal Reserve has lifted interest rates this year. Similarly rated corporate bonds traded on average on Tuesday with a yield of 9.64 per cent, according to Ice Data Services.

Carnival is not the only one paying a premium due to the turmoil in financial markets. Junk-rated companies have had to offer an average yield of 12.25 per cent to raise new debt in October, PitchBook LCD data showed. Last week cinema operator AMC borrowed $400mn at a yield of 15.1 per cent to finance a subsidiary.

As part of the bond deal, Carnival’s parent company has transferred 12 vessels, most of which became operational in the past two years and have a combined value of $8.2bn, to a subsidiary which ultimately issued the bond, using the ships as collateral.

John McClain, a high-yield portfolio manager at Brandywine Global Investment Management, said the bond showed Carnival was “getting creative” with collateral to avoid paying “eye-watering” interest rates. “Without the ships, I don’t believe that they would have access to capital at a price they would have been comfortable with,” he said.

Its share price is down 62 per cent this year to just above $8 but rallied more than 11 per cent on Tuesday after the bond was announced.

The structure of the bond, which matures in 2028, puts the lenders “at the front of the line” for any claim on the 12 vessels in the event that Carnival is unable to meet payments, said Ross Hallock, head of high-yield research at Covenant Review.

Carnival has had to contend with a ballooning debt pile, totalling about $35bn as of early September, in the wake of the pandemic. Meanwhile, recovery in cruise bookings has lagged. Last month, the Miami-based company reported a net loss of $770mn for its fiscal third quarter.

Carnival’s dollar-denominated senior unsecured bonds maturing in 2026 rose as much as 4.7 per cent on Tuesday, in a sign of reassurance about the company’s cash flow, but they continue to trade well below face value, according to bond trading platform MarketAxess. At the start of the pandemic, the company offered bonds secured against its 80-plus fleet to entice investors.

Still, some traders said the cruise sector’s vulnerability to economic downturns and Carnival’s high level of debt meant the double-digit yield on offer was not high enough.

“When I see 11.5 per cent for highly cyclical, highly levered US corporates and compare it with others in the market [that are offering similar yields], I’m not impressed,” one investor said. “North of 15 per cent is when it becomes interesting . . . It’s not difficult to find yield in this market.”