There are “far more attractive homes for clients’ money” than consumer staples stocks, according to Invesco Perpetual’s Stephanie Butcher who has criticised high valuations and deteriorating fundamentals in the sector.
The Invesco Perpetual European Equity Income fund manager said the consumer staples sector – and more specifically the foods, beverages, household & personal care stocks – is a key underweight with consumer goods making up just 5.1 per cent of the £798.3m fund.
She said: “We remain significantly underweight the consumer staples sector. We believe it is overvalued against the market and its own history.
“It has an extremely tight correlation to the bond market, which we also feel is overvalued.”
Butcher added: “On top of this, the underlying fundamentals that underpin the qualities of security and defensiveness that investors find attractive about the sector are deteriorating.
“In an environment in Europe of robust economic growth, positive inflation and recovering earnings growth, we find other areas of the market far more attractive homes for clients’ money.”
The manager noted that consumer staples stocks have re-rated “significantly” during the past few years, particularly since the global financial crisis.
Performance of MSCI Europe/Consumer Staples index over 10yrs
Source: FE Analytics
Indeed, the MSCI Europe/Consumer Staples index has returned 180.88 per cent over the past 10 years, compared with a 67.94 per cent rise for the broader MSCI Europe index.
Consumer staples have been labelled by many as ‘bond proxies’ in recent years for their bond-like characteristics, most notably their higher yields and more defensive qualities.
Butcher said the perceived quality of low volatility earning streams, steady growth and strong balance sheets had contributed to making the sector “the poster child of stable, defensive security in a low growth, deflationary world”.
“The premium attached to the sector has steadily risen, and for some time on absolute and relative multiples we have found it difficult to find many stocks which provide adequate valuation support to merit a position in the portfolio,” she added.
Butcher said: “The point about a low growth environment is an important one, because in our view the macro backdrop has been absolutely central to the re-rating of the stocks.
“This is no more clearly demonstrated by charting a simple relationship between the sector and the 10-year treasury and bund yield – it is almost one-for-one.”
The manager said Invesco Perpetual believes bunds are trading at “unsustainably low” yields and are likely to rise as the European Central Bank (ECB) begins the tapering process.
Indeed, the process to remove stimulus measures introduced to shore up the eurozone is likely to begin later this year after ECB president Mario Draghi hinted at a November start.
In addition, Butcher said there had been evidence that the merits of the sector have been overstated.
She said during the period of re-rating, revenue growth & volume growth, quality of earnings and returns have all deteriorated as balance sheet leverage has increased.
“Reasons behind this are various, but include the increasing fragmentation of distribution channels, making it much easier for new brands to start up, plus the increased outsourcing of manufacturing. Anyone can start up a brand and find someone who can make the product for them,” she said.
“These are both areas which previously acted as moats to the large companies given the advantages of scale.”
Balance sheet leverage has moved higher in the absence of organic growth, with companies in the sector forced to buy growth instead.
Other challenges for consumer staples stocks, said Butcher, included slower growth in emerging markets, the emergence of serious non-western competitors and the rising importance of private label brands.
A further challenge for the sector was the appearance of activist investors that have taken more aggressive stance demanding that companies slash costs to drive up margins, said Butcher.
While this has contributed to steep drops in marketing budgets, she said long-term evidence suggests a clear relationship between growth and advertising.
The manager explained: “These cost cuts appear to be very short-term in their thinking, and we suspect that advertising spend will need to increase again over time, impacting margins.”
Butcher said that a focus on valuations is the over-riding philosophy behind allocations in the three FE Crown-rated Invesco Perpetual European Equity Income fund.
She said: “In terms of performance, what we don’t hold can be just as important – particularly if an individual stock, sector or factor is a major index constituent.
“By not holding them, we are explicitly taking a position against the index which is contributing to our active share.”
Butcher added: “To our minds over-paying for any asset, whatever its quality, is taking on additional risk.”
Performance of fund over 3yrs
Source: FE Analytics
The biggest sector exposure for the European income fund is to financial stocks, which represent 27 per cent of the portfolio and includes firms such as BNP Paribas, ING and Caixabank among the top 10 holdings. The fund also has significant exposures to the industrials and oil & gas sectors, representing 18.6 per cent and 11.8 per cent respectively.
The fund has delivered a return of 40.82 per cent over three years, compared with a 44.86 per cent gain for the average IA Europe Excluding UK fund.
Invesco Perpetual European Equity Income has a historic yield of 2.9 per cent and an ongoing charges figure (OCF) of 0.94 per cent.