Disinflationary trends have been prevalent in developed economies since the financial crisis, with the US in particular struggling to reach or sustain its target 2 per cent rate of inflation.
This environment has meant that many businesses have found sales and earnings growth harder to generate than during the years leading up to the financial crisis.
While market pressure could encourage these businesses to simply cut costs, those that are investing in their own futures offer the most attractive opportunities for investors.
The three ‘Ds’ – high global debt levels, ageing demographics and technological disruption have been signature motifs of the last few years and they remain key drivers of the macroeconomic backdrop.
These disinflationary trends continue to provide a challenge for companies in terms of pricing power and overall growth rates, and we are seeing the effect across all industries.
As a result, many companies are seeking to become more efficient, to counter the effects of this trend.
This general drive for efficiency is perhaps the most ubiquitous theme we see across all the different sectors and industries we follow. Wherever you look: better data analytics, upgraded IT infrastructure, more rational manufacturing facilities, improved supply chains and procurement systems are being worked on. When done well this represents a positive development. Management information is better, less mistakes are made, customers are happier and profits rise.
Striking the right balance
The risk with ‘efficiencies’ of course, is that they sometimes come not only from operational improvements, but also from investment cuts to those things that drive product quality and future growth such as brand investment, innovation, research & development, and geographical expansion.
It is important that management get the focus right here and it is one of the topics we’ve been discussing with companies in detail of late.
Two good case studies are Informa and Smiths Group. Both were underinvesting several years ago, but new management teams have made good progress in stepping up organic investment levels to drive future growth.
Capturing consumers
In the consumer staples sector, this balance between efficiency and investment is particularly interesting at the moment.
The real and perceived threat of acquisition has put some pressure on the industry to optimise financial results (the advertising industry is feeling the pinch from this, as WPP’s latest results demonstrated ‐ the company has several large clients in the consumer staples industry). But equally, consistent investment remains very important – even in a stable, mature industry such as consumer‐branded goods.
The world is moving on: consumer preferences are changing, the retail landscape is evolving and as shoppers we are beginning to purchase more of our groceries and personal care products through digital channels.
Globally‐dominant brands are very well placed to cope with these shifts, but they will need to keep investing in branding, innovation and channel development to maintain their strong positions.
Looking further afield
Global brands also continue to have a tremendous growth opportunity in developing markets, which they should ensure they invest behind fully.
Per capita spend on repeat‐purchase food, household and personal care brands is six times greater in developed markets than in the emerging world and the gap continues to close – despite economic downturns in some of these regions over recent years.
Unilever’s latest results showed continuing good growth and outperformance of its markets, and it was interesting to note a more optimistic tone from management on the emerging market outlook than has been heard for some time.
Elsewhere, we have been encouraged by the investments that companies such as Diageo, Pepsi and PZ Cussons are making in innovation, branding and distribution networks.
The current backdrop is providing opportunities as well as challenges. Many businesses are seeing the ability to harness technological change, helping their (primarily corporate) customers cope with a changing world by offering products and services that increase efficiency and productivity.
Software analytics and proprietary data are often key planks in this strategy and some of the best examples are in the business‐to‐business information and software sectors – companies such as Informa, DMGT, Relx, Euromoney, UBM, Sage, Fidessa, Aveva and EMIS.
Although disinflationary trends are still challenging businesses, there are also opportunities for businesses to grow in the current environment.
While many have turned to cost cutting as a means to improve their financial profiles, by investing strategically and seeking out new markets or products, others are achieving organic growth and building sustainable businesses for the long term.
Hugh Yarrow is chief investment officer and fund manager at Evenlode Investment Management. The views expressed above are his own and should not be taken as investment advice.