* Weak EMs, stagnant DMs, rising EM competition and deflation…
Staples growth remains sluggish in EMs owing to tough macro conditions
and in some cases rising category maturity. DM recovery will likely be
subdued for staples as QE and lower oil price benefits are spent on more
discretionary categories. In EMs, MNCs are beginning to lose share to EM
players. There are growing signs of deflationary pricing in categories that
lack pricing power as input costs fall. While long-term growth and returns
characteristics are attractive, we expect staples to deliver CY16-18 EPS
growth 2% lower than the market, despite expecting material, accretive
M&A. At the same time, earnings volatility has reached 15-year highs.
* …yet valuation is close to all-time high; we see a 15% de-rating…
Despite a weakening growth outlook, European staples trades on 20.3x
12-month forward P/E, and has only traded above this level for 15 weeks
over the last 25 years (1%) during the tech bubble. The last time staples
traded at c.20x 12-month forward P/E, it experienced a relative de-rating of
15% over the next year (29% over two years). While the current premium
(34%) to the market is in line with history, it is unusual for the premium to
be sustained with the market at these elevated levels. Historically, staples’
premium has tracked US bond yields, with rising yields leading to a falling
premium. Assuming US yields increase to 3% (as per our economists) and
that the market remains flat, we estimate staples’ 12-month forward P/E
should fall to c.17.5x, a 15% de-rating, or a US$200 bn drop in market cap.
* …and dividend/cash flow support is better elsewhere
For CY15E, 15 of the 26 sectors covered by GIR offer higher dividend yields
than European staples; 13 offer higher FCF yields. For better dividend yield
and free cash flow with lower earnings volatility, see our ‘Income Plus’
basket (GSTRHYLV). By CY18E, staples offers a FCF yield 1.7% below the
market, having never traded at more than a 1% FCF discount historically.
To bring staples back to FCF parity would require a 22% reduction in the
sector’s market cap, or similar upgrades.
*Three new Sells; Danone to CL Sell; we continue to prefer self-help
We update estimates for current trading and FX and update our M&A
framework. We downgrade Diageo, Campari and Henkel to Sell from
Neutral. We add Danone to the Conviction Sell List and downgrade SCA to
Neutral from Buy. Our top picks offer either self-help via cash deployment
(ABInBev, L’Oreal), defensive growth (Chr Hansen) or should benefit from
falling input costs (Britvic).