What Will Make Consumer Staples No Longer a Good Defense?

Ahmad Dwiki Pradany
Nov 3 · 5 min read

For most defensive investors, consumer staples (FMCG, alcohol, tobacco, etc) is the most favorite stocks because relatively easy to understand’s business, lower price volatility unlike Commodity or Property, and most of the times it keeps making money and paying out dividends even in the hard times. Those advantages make it categorised as ‘safe stocks’ especially for those who just start investing.

With those characteristics, consumer staples are traded at premium price by the market, such as Unilever Indonesia which valued at 40 times earnings and Indofood CBP at 26 times earnings. However, I won’t talk about whether those valuation can be justified or not in this article.

When it comes to Capital Market, less risk doesn’t mean risk-free, there will always be some risks that attributed to any kind of investment (except government bonds), and Consumer Staples stock is no exception. Some possible risks are when the market is panic, or business goes wrong (eg: TPS Food accounting fraud scandal), or regulation goes against the business (product ban, tax rise), and many more. Therefore, it’s important to be aware of the risk and measure its potential impact.

For the consumer staples business, raw material, salary, sales price, and sales volume are the most important factors for the business operation. Therefore, in this mini-research I simulated the impact of those factors on the pretax income, when each operation component is 10% worse. For the data, I used the company’s 2019 third-quarter income statement from 13 listed consumer staples company, and here is the list of the companies:

  1. PT. Delta Djakarta (DLTA)
  2. PT. Gudang Garam (GGRM)
  3. PT. Garuda Food Putra Putri Jaya (GOOD)
  4. PT. HM Sampoerna (HMSP)
  5. PT. Buyung Poetra Sembada (HOKI)
  6. PT. Indofood CBP Sukses Makmur (ICBP)
  7. PT. Kalbe Farma (KLBF)
  8. PT. Multi Bintang Indonesia (MLBI)
  9. PT. Mayora Indah (MYOR)
  10. PT. Tempo Scan Pacific (TSPC)
  11. PT. Industri Jamu dan Farmasi Sido Muncul (SIDO)
  12. PT. Ultrajaya Milk Industry & Trading Co. (ULTJ)
  13. PT. Unilever Indonesia (UNVR)

Based on their Q3 income statement data, I broke down the cost structure of the company, then I’ll assume each of the expense, namely raw material and salary goes up by 10%, while sales price and sales volume goes down by 10%, to understand how each of them affects pretax income individually. Below are the results:

Raw Material Cost

Raw material is the materials that will be processed to make finished goods. It’s play the key role in any business operation, without raw material the business can’t make any sales. Just imagine what will HM Sampoerna will sell to you if we run out of tobacco? So, it’s important to analyse the impact of raw material cost to pretax income.

When the raw material costs rise 10% and another variable is remain unchanged, the impact on pretax income varies widely between each individual. Impact ranging from 3.85% to 101.06%, which means some companies wouldn’t be much affected while another will suffer losses if the raw material expense goes up by 10%, shown by the graph below:

Based on the magnitude of its impact, we can see that $DLTA and $HMSP are not much affected while $GOOD, $MYOR, and $HOKI will suffer a significant decline if the raw material cost rises.

Salary Cost

Historically, salary expense grows each year due to government policy of raising minimum wage, following GDP growth and inflation. Because this is expected to happen each year, management are prepared facing this issue. As a result, you can see from the graph below, most companies are not much affected by a 10% rise in salary expense. The average loss is -5.99%, which can be easily offsetted by a small rise in price. Out of those companies, only $GOOD and $TSPC will suffer moderate decline of pretax income, -19,09% and -16,67% respectively.

Price Decline

Now imagine, you go to your local shop to buy your favorite candy or perhaps for some groceries, then you see everything on the shelves is 10% off for 1 year period! Literally everything, from your favorite instant noodles to your toothpaste and soap. Sounds great, right? No, not for the company producing it.

As you can see, most of the company will suffer significant decline (-73.88% on average) on pretax income if they bring down the price 10% for a full year period. Some of them even suffer significant loss ($HOKI, $MYOR, $GOOD, $TSPC). So, a full year 10% discount is definitely threatening risk.

Sales Volume Shortfall

Well, what you expect here? If the sales decline, then how on earth you expect the pretax income go up! However, on interesting point found from this simulation is, the impact of volume shortfall is not as bad as a full year discount. On average, companies will have 32.47% of pretax income decline if the sales volume decline 10%, compared to 73.88% if price declines by 10%(still bad though).

The simulation above also shows that the decrease in sales volume affects each company differently. There are companies that will suffer moderate decline such as $DLTA and $HMSP (-17.24% and -17.52% respectively) while other company like $GOOD and $MYOR will suffer big decline (-62.43% and -54.48% respectively).

Conclusion

With all the possibilities above, we should be able to understand when is consumer staples no longer a good defense. Ordered by magnitude of the impact, the biggest impact, of course is the price decline a.k.a full-year discount, but this event is very unlikely to occur, the second one is sales volume decline and raw material cost increase, which could happen when the natural disaster, recession, or other major political and economic event come, lastly the rise in salary cost, which almost certainly happens each year, but doesn’t have much effect due to mitigation done by the management.

Last but not least, if you pay attention to the data, you’ll find another interesting point there. Yes, the alcohol stocks ($DLTA and $MLBI) always outperform industry average and show up as less impacted performer in every scenario.

Ahmad Dwiki Pradany

Written by

Intrested in Business, Investing World and Capital Market. And also, I love individual freedom.

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