A recent study of the European consumer staples sector by RBC throws up some interesting findings, especially in light of the underperformance of the sector in 2013 as shown by the following graph:
So, what gives?
Recently, Bruce Greenwald carried out a virtual Fireside Chat with Li Lu, the founder and chairman of Himalaya Capital. Greenwald and Lu covered multiple topics during the discussion, addressing everything from the value investor's approach to appraising businesses and what he had learned from his great friend Charlie Munger. The duo also discussed China's economy Read More
RBC found that over the last decade, a company’s ‘Return on invested capital’ (ROIC) really had no correlation with how the stock performed in the market. RBC plotted ROIC with the company’s relative share performance and the resulting graph (below) shows this up effectively:
But surprise, surprise … what did work for share prices was growth in capital employed.
When RBC matched up the growth in capital employed with share price performance they found a correlation coefficient between the two of over 50% – OK not so great, but still showing that a relationship existed, as per the following chart:
RBC therefore concludes that, over the last decade, “those companies deploying the most incremental capital have generally been rewarded by the stock market over the last decade in contrast to those that have expanded their businesses relatively modestly.” In other words, investors have been “excessively tolerant” of low returns in the sector, to the point of fault.
If this is what drove prices so far, what does the under-performance in 2013 indicate? Remember that the STOXX600 Food and Beverage sector beat the performance of the European market during 2007 through 2012 … every year.
The under-performance in 2013 could lead investors to refocus: RBC
According to RBC the under-performance in 2013 could lead investors to refocus on returns – the lifeblood of an investment/business.
The best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return. – Warren Buffett, 1992.
That said, RBC feels that the under-performance in the sector will lead to a heightened scrutiny of the companies’ returns, and shareholders may demand a return of capital instead of a blind plowback into operations generating sub-par returns.
In this new scenario the companies that would thrive are the ones focused on returns, not the ones looking for growth. Here are RBC’s ratings in this context:
Anheuser Busch Inbev SA (NYSE:BUD) (EBR:ABI)
Carlsberg A/S (OTCMKTS:CABGY)
Nestle SA Reg Shs. Ser. B Spons (OTCMKTS:NSRGY)
PERNOD RICARD SA (OTCMKTS:PDRDY)
Danone SA (OTCMKTS:DANOY)
SABMiller plc (LON:SAB) (OTCMKTS:SBMRY)
Unilever N.V. (NYSE:UN)
Diageo plc (NYSE:DEO)
Heineken N.V. (OTCMKTS:HINKY) (AMS:HEIA)
L’oreal S.A (OTCMKTS:LRLCY) (EPA:OR)
Reckitt Benckiser Group Plc (OTCMKTS:RBGPY) (LON:RB)