Matthew Tillett: Follow Mr Market before consumer crash

Warren Buffett famously favours companies that “buy commodities and sell brands”.

The consumer staple companies certainly fit the investment king’s description: their products — basic personal or household items such as shavers, toothpaste or washing-up liquid — are cheap to produce, but sell at a relative premium, packaged in ubiquitous brand names that dominate supermarket shelf space.

In the jittery macroeconomic environment of recent years, these companies have become safe haven investments.

Their shares have significantly outperformed the stock market on the basis of seemingly reliable cashflow and dividend streams. Some commentators even refer to them as “the expensive defensives” because of this.

But looking ahead, the investment case for these companies may be far less rosy. I see two headwinds:

First, powerful long-term structural changes in consumer behaviour are slowly undermining the dominant position occupied by many consumer staple brands. The vast majority of basic household products are still purchased on the High Street, but e-commerce is growing rapidly in this space.

Experience from other industries suggests that scale is the critical factor here. The manufacturers of products where usage is regular and predictable, and shipping costs are low, have shown themselves to be particularly vulnerable to disruption.

Witness the recent success of Dollar Shave Club in the US as a model of things to come.

E-commerce has already eroded the business models of many high-street retail brands such as Blockbuster, HMV or Comet. That’s not the biggest danger for consumer staples. Instead, their problem is growth — or lack of it. As e-commerce penetration increases, it will be harder for consumer staples to sustain their already fairly pedestrian growth rates.

Again, experience from other industries suggests it is not the incumbents who capture this new online growth, but the more innovative and recent entrants to the market. One solution is to acquire this growth, as Unilever did with the aforementioned Dollar Shave Club.

Yet these acquisitions come at the cost of diluting the firm’s overall return on capital, as they will only be possible at very high valuations.

Another solution is consolidation. In the past few weeks, Reckitt Benckiser has agreed to buy Mead Johnson, and Buffett’s Kraft Heinz has attempted — but failed — to buy Unilever.

These deals are about cutting costs and leveraging balance sheets to create a more attractive earnings growth trajectory.