Consumer sectors continue to face the twin headwinds of low consumer confidence/likely lower demand and inflationary cost pressures. The pressures on prospective consumer demand are likely to have intensified in recent months, notably from higher interest rates. As we head into the winter months, the scale of utility bill increases will become fully apparent to consumers. Although downgrades to profit estimates for the majority of sectors continued in Q322, consensus estimates still expect strong profit growth in CY22 and CY23 for the majority of sectors, which feels incongruous given the obvious pressures on consumer spending and company costs. We remain cautious about a wholesale rapid recovery in sentiment towards the more cyclical sectors given our fears for profit estimates. However, we have identified more than 100 companies that appear to have fully discounted a decline in revenue and profit and, importantly, which consensus expects to generate positive free cash flow (FCF) across CY22 and CY23.
Cost inflation pressuring profits
During Q322, UK and European consumer sectors typically enjoyed upgrades to CY22 consensus revenue estimates, but the picture was reversed in North America as forecasts declined. Relatively high inflation is helping to buoy reported revenues as pressures on consumer demand and volume growth mount. The strength of the US dollar versus other currencies is undoubtedly helping overseas companies with US exposure and, conversely, hurting revenue estimates for US companies with overseas exposure. However, inflationary pressures on cost bases are working against companies too, leading to downgrades to CY22 operating profit estimates for North American consumer sectors and restricting profits in the UK and Europe. Consensus estimates still expect the majority of sectors to report growth in revenue and operating profit in CY22 and, perhaps more importantly, in CY23. In aggregate, consensus expects y-o-y operating profit growth of 20% for the UK consumer sectors in CY23, 8% for Continental Europe and 18% for North America. Therefore, we believe profit expectations appear too optimistic and are vulnerable to further downgrades.
Consumer sectors underperformed in Q322
As might be expected with a deteriorating macroeconomic outlook, consumer sectors, in the main, underperformed their regional indices in Q322. However, there was not a consistent trend across the regions: we note with interest that the majority of outperforming sectors in North America in Q322 were discretionary sectors. Elsewhere, performance was more balanced between the discretionary and staples sectors, as investors continued to seek shelter in defensives sectors. Despite the poor outlook for profit estimates, we have identified more than 100 companies across the regions (see Appendices 1, 3 and 5) that are already trading at significant discounts to their long-term low EV/Sales multiples when we assume a 10% y-o-y decline in CY23e revenue from current CY22 estimates. This suggests the market is either discounting a more significant decline in revenue, or greater margin pressure, than experienced during the most recent economic downturn.
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