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Why consumer stocks can withstand a commodity rally

  • The US-China trade detente and simmering Iran tensions have increased the likelihood of a commodity rally

  • Such a rally would impact the margins of consumer companies

  • Our Teflon Test show branded consumers are well protected; food processors and retailers in the danger zone

Why consumer stocks can withstand a commodity rally
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

Tellimer Research
30 June 2019
Published by

The US-China trade detente and simmering Iran tensions have increased the likelihood of a commodity rally, in our view. Such a rally would impact the margins of consumer companies. We have devised a metric called the Teflon Test that measures the susceptibility of companies to interest rate hikes and higher cost of goods. Our Teflon Test stress tests companies’ balance sheets using six key metrics.

Commodities could boom with an end to the trade war

Commodities have been sliding in the face of trade tensions. Over the past 12 months, the Bloomberg Commodity Index has dropped 15% as the US-China trade war intensifies (for more on trade wars and their impact on EM, see our recent report). The fundamental demand/supply issues are unchanged. 

Bloomberg Commodity Index is down 15% in the last year

Source: Bloomberg

This slide has come despite a recent oil rally, which underlines the depth of the drop in agricultural and industrial commodities. Oil has risen 10% since the Gulf crisis arose. The demand/supply fundamentals of several commodities are tight. There has been chronic underinvestment in energy since the 2014 crash, while food commodities such as corn, wheat and soy are facing adverse weather. Flooding has devastated the latest crop in the US, and palm oil supply may be affected by the prospect of El Nino.

Agricultural commodities are ripe for a rally 

Palm Oil is at a 10-year low. Meteorologists have warned of the prospect of El Nino, a climatic condition that reduces palm oil production. Similarly, the USDA has alerted the market of a corn shortage due to exceptional wet weather in the US, the main global producer.

Palm Oil is at a 10-year low

Source: Bloomberg

Our basket of 42 EM & FM consumer companies has underperformed the S&P 500, MSCI EM and MSCI FM by 15-25% YTD. The risks of high debt and depreciation seem to have been absorbed. In several cases, elections have been a boon for consumer spending. We have seen stronger sales of key consumer items such as liquor, basic food and snacks.

In the danger zone: Food processors and retailers

The ‘danger zone’ of our consumer stock coverage has underperformed the key indices by 13-21% YTD. This suggests to us that the downside risks of debt and depreciation are factored in. We find that more branded consumer companies are more immune to the risks. In contrast, the food processors and retailers (such as WIL SP, FLOURMIL NL and CPALL TB) are among our 10 'danger zone' companies.

Well protected: Branded consumers

Our principal recommendations are branded and close to the bottom of the valuation cycle. These include THBEV SP, CPF TB, NESTLE NL and NB NL. Among non-rated companies, INDF IJ and CPIN IJ look promising. Branded consumer plays are resilient to the risk of debt, depreciation and higher input prices and typically have steady cash generation. THBEV SP and CPF TB have net gearing levels of more than 100%. Encouragingly, they are deleveraging and converting their debt into Thai baht.