Value emerging
The consumer sectors are facing a perfect storm of declining demand (lower real incomes and consumer confidence) and widespread inflationary pressures, which we believe are unlikely to abate quickly. Although downgrades to profit estimates have begun, we believe the full impact of the economic downturn is yet to be reflected in what appear to be optimistic growth expectations for the majority of companies. The share prices of the companies have been quick to recognise the deteriorating outlook, with notable outperformance by those with revenues and profits that are customarily less sensitive to macroeconomic changes. We would be cautious about expecting a wholesale quick recovery in sentiment towards the consumer sector given the greater uncertainty on profits due to unusually high inflation. We highlight a number of companies already sufficiently discounting a reduction in revenue, many of which have a net cash position.
Revenue upgrades offset by cost pressures
The consumer sectors across Europe and North America mainly enjoyed upgrades to CY22 consensus revenue expectations through Q222, as life continued to return towards normal post the disruption caused by COVID-19 in 2020 and 2021. However, strains on consumer spending began to emerge during Q222 and the well-flagged inflationary cost pressures, particularly inputs and transportation, weighed on profit expectations for 2022 Despite the deteriorating macroeconomic trends, consensus (source: Refinitiv) expects the majority of sectors to report revenue growth in 2022 versus 2021, and again in 2023. While the revenues of many companies continue to recover post COVID-19, and higher inflation (versus previous downturns) may support revenue growth, we believe consensus revenue forecasts may be too optimistic. Potential downgrades to revenue estimates are likely to be compounded by ongoing inflation. Therefore, we believe consensus profit estimates for many companies are vulnerable to new and/or further downgrades.
Share price declines leading profit downgrades
The expected macroeconomic weakness has wrought havoc with the share prices of many of the companies already, particularly those exposed to consumer discretionary spend. The length and depth of the economic slowdown and potential reductions in revenues and profits remain difficult to predict. To identify valuation opportunities at the corporate level we have applied a ‘blunt’ 10% cut to CY21 revenue to estimate future revenue. We rationalise the 10% reduction by 20% lower real demand, similar to the revenue declines seen in the 2008/09 downturn when inflation was lower than today, offset by 10% inflation. This may be overly conservative for some companies, given, say structural growth drivers or the lifecycle of the company. We highlight 50 companies in each of the UK and Continental Europe that, using this assumption, appear to be trading below their long-term average EV/sales multiples. Some caution is warranted when comparing prospective multiples for companies with a shorter trading history, given the effects of higher interest rates and inflation on WACCs. In addition, high cost inflation is likely to make achieving cost savings more difficult than the most recent economic downturn.
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