One of the most exciting sectors in which to invest is consumer goods. That’s because, historically, it has offered a potent mix of excellent growth potential and superb defensive qualities, with increases in earnings being backed up by relatively wide economic moats due to a high degree of customer loyalty.
However, the consumer goods sector is being hit very hard at the present time, with the world’s second largest economy, China, enduring a challenging and uncertain period. As such, while the market had taken strong demand from an increasingly wealthy emerging world for granted, it appears as though consumer goods companies will have to work hard to ensure that their brands maintain strong sales momentum.
Clearly, the likes of Diageo (LSE: DGE) and SABMiller (LSE: SAB) have been hit hard by weak demand from China. The two alcoholic beverages companies both reported a decline in earnings in their most recent financial years, with Diageo’s net profit falling by 7% and SABMiller’s declining by 1%. Looking ahead, neither company is due to mount a game changing comeback in the current year, with Diageo’s bottom line forecast to rise by just 3%, while SABMiller’s earnings are expected to decrease by 2%.
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Meanwhile, Unilever (LSE: ULVR) has been hit somewhat less hard by the Chinese slowdown. Its bottom line may have increased by just 1% last year, but is expected to increase by 13% this year, followed by further growth of 7% next year. This is partly due to Unilever’s greater diversity of products, with the company selling a range of consumer goods from ice cream to shampoo. Therefore, it may be more resilient than the pure play beverages companies such as Diageo and SABMiller.
Clearly, Diageo and SABMiller have excellent portfolios of brands but many investors will have a hard time justifying their current valuations. For example, the two stocks trade on price to earnings (P/E) ratios of 19 and 21.1 respectively which, given their near-term growth outlook and recent performance, seems somewhat expensive. Unilever, though, may have a similarly high P/E ratio of 20.5 but, with its brighter growth potential, its price to earnings growth (PEG) ratio of 1.6 indicates good value for money.
In addition, Unilever also has far more appealing income prospects than either Diageo or SABMiller. For example, it has a yield of 3.2% versus 2.4% for SABMiller and, while Diageo’s yield is slightly higher than Unilever’s at 3.4%, the latter is expected to raise dividends by 5.6% next year and, looking ahead, its superior outlook is likely to mean faster dividend rises over the medium term, too.
Of course, Diageo and SABMiller are both very high quality companies that have the potential to benefit from a sound long term growth story across emerging markets. They both have excellent brand portfolios and strong management teams but, when compared to Unilever, its greater diversity of products, superior growth prospects and more appealing valuation make it the preferred option of the three at the present time.
