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Sustainable Investing

Changing Consumer Behavior – Who Benefits?

By  Mike Rode, CFA
Consumer at grocery store.

Key Takeaways

Strong consumer demand for discretionary goods during the pandemic has shifted toward services and consumer staples due to soaring inflation and recession fears.

Many retailers are now stuck with inventory that consumers no longer want.

In this uncertain environment, we believe companies that focus on consumer staples may hold up better than those focused on discretionary purchases.

Winds Are Shifting for the U.S. Consumer

The U.S. consumer has enjoyed an extraordinary run over the past few years, driven largely by changes brought by the COVID-19 pandemic. The job market has been remarkably strong, and many households built up savings from government stimulus money and reduced spending on activities curtailed by COVID restrictions.

A strong housing market was boosted by limited inventory combined with surging demand from millennials seeking to form households, low mortgage rates and the ability to work from home. This combination of factors led to all-time highs for the equity consumers have in their homes, boosting household net worth.

But thanks to soaring inflation, rising interest rates, geopolitical uncertainty and painfully high prices at the gas pump, consumer sentiment quickly deteriorated in 2022. In the second quarter, the world’s largest retailers (think Target and Walmart) noted a dramatic shift in shopping habits. Customers slowed purchases of “nice-to-have” discretionary goods like furniture and TVs and increased spending on travel and “must-have” items like food and personal care products. The result? Many retailers have gluts of inventory.

Increasing Inventories at the Wrong Time

Target CEO Brian Cornell acknowledged the company’s inventory woes in a recent interview. “I left New York and I spent time in different parts of the country, in our stores and in competition, looked at syndicated data and recognized that U.S. retail overall, we're looking at historic highs with inventory levels.”1

Retailers ordered goods based on the unprecedented consumer behavior of the last two years. Supply chain constraints and extended shipping times also forced them to place orders well in advance without great visibility of future buying patterns. Now that shoppers have shifted spending away from discretionary goods, retailers must mark down excess inventory to make room for back-to-school and holiday merchandise, which is likely to hurt profit margins.

As you can see in Figure 1, inventory growth at certain retailers has accelerated to the 40% range while sales growth has slowed to single digits. This is a severe mismatch.

Figure 1 | Inventories Outpacing Sales Growth

Line chart showing that inventory growth is outpacing revenue growth by nearly 40 percent through April 30th 2022.

Data from 1/31/2020 – 4/30/2022. Source: FactSet.

Investors anticipate heavy discounting will likely reduce profitability for these retailers, which is already affecting the share prices of companies like Target and Walmart. See Figure 2.

Figure 2 | Changes in Spending Habits and Excess Inventory Weigh on Leading Retailers

Target Price Change (%)

Line chart showing Target's stock price change from December 31st of 2021 through June 30th 2022. It fell roughly 40 percent from April of this year to the end of June.

Walmart Price Change (%)

Line chart showing Walmart's stock price change from December 2021 through the end of June 2022. It fell almost 20 percent from the middle of April to the end of June.

Data from 12/31/2021 – 6/30/2022. Source: FactSet. Past performance is no guarantee of future results.

More Groceries, Fewer Gadgets

Given the notable shift in the types of things consumers are buying, we are seeing more opportunity in consumer staples than in consumer discretionary stocks.

Within the consumer staples sector, food company profit margins have historically tended to be stable even when inflation is high. See Figure 3. As raw materials costs go up, food companies can increase the prices they charge retailers and/or reduce the amount in each package while keeping the price the same, a practice commonly known as “shrinkflation.” Your cereal box that used to contain 12 ounces may now hold 11.4 ounces, a 5% cut.

Figure 3 | When Food inflation Is High, Consumer Staples Company Profit Margins Tend to Be Stable

Consumer Price Index - Food-at-home vs. Consumer Staples Operating Margins

Food CPI vs. Consumer Staples Operating Margins.

Data from 1/1/1987 – 4/30/2022. Source: FactSet. Consumer Price Index - Food reflects changes in food prices. Russell 1000 Consumer Staples - Reflects the consumer staples sector of the Russell 1000 Index (excluding consumer staples retailers).

Food companies are also adapting to shifting consumer preferences in both the U.S. and abroad. For example, Kellogg reports growth in the snacking market in the U.S. with brands such as Pringles®, Cheez-It® and Pop-Tarts®. The company has also seen steady growth in the highly profitable cereal category the company serves with iconic brands such as Froot Loops®, Frosted Flakes® and Special-K®.

Consumer staples — food, diapers, shampoo — are typically purchased weekly or even more often. Customers usually have a high brand affinity for these items and are less likely to trade down or defer purchases to save money. This buying behavior helps many consumer staples companies have the potential to offer stable and growing dividends even in inflationary or recessionary environments.

In contrast, consumers tend to make discretionary purchases every 1-7 years at higher ticket prices. Buying decisions in this category tend to be more sensitive to price and economic conditions.

ESG Issues for Consumer Staples Companies

While the consumer staples sector is vulnerable to certain environmental, social and governance (ESG) risks, it also has ESG opportunities as investors are increasingly aware that pursuing sustainability is good business.

For example, single-use plastics and wasteful packaging present both a risk and an opportunity. Leading consumer staples companies can promote customer loyalty by reducing plastic use and potentially cut costs by reducing wasteful packaging.

When we analyze food companies, we also pay attention to how workers are treated across the supply chain, the carbon footprint involved in shipping products to customers globally and the impact of climate change on agriculture. ESG considerations are integrated into many of our investment decisions, and we engage directly with company management on these issues as warranted.

Adapting to Changing Preferences and Economic Headwinds

After spending the pandemic cooped up at home, consumers have been eager to get out of the house and participate in experiences such as dining, entertainment and travel. This shift in behavior has caught some companies that make and sell discretionary home products such as furniture and electronics off guard and left them with overstocked warehouses and shelves.

At the same time, the Federal Reserve has launched an aggressive inflation-fighting campaign that threatens to derail economic growth. These developments have helped create a volatile investment environment that may be more conducive to makers of everyday consumer staples that have a history of stable performance regardless of the economic backdrop.

Mike Rode, CFA
Mike Rode, CFA

Vice President

Senior Investment Director

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Brian Sozzi, “Target CEO on inflation, Inventories,” Yahoo Finance, June 21, 2022.

References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Many of American Century’s investment strategies incorporate sustainability factors, using environmental, social, and/or governance (ESG) data, into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider sustainability-related factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh sustainability factors when making decisions for the portfolio. The incorporation of sustainability factors may limit the investment opportunities available to a portfolio, and the portfolio may or may not outperform those investment strategies that do not incorporate sustainability factors. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.

Sustainable Investing Definitions:

  • Integrated: An investment strategy that integrates sustainability-related factors aims to make investment decisions through the analysis of sustainability factors alongside other financial variables in an effort to make more informed investment decisions. A portfolio that incorporates sustainability factors may or may not outperform those investment strategies that do not incorporate sustainability factors. Portfolio managers have ultimate discretion in how sustainability factors may impact a portfolio’s holdings, and depending on their analysis, investment decisions may not be affected by sustainability factors.

  • Sustainability Focused: A sustainability-focused investment strategy seeks to invest, under normal market conditions, in securities that meet certain sustainability-related criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. Alternatively, or in addition to traditional financial analysis, the investment strategy may filter its investment universe by excluding certain securities, industry, or sectors based on sustainability factors and/or business activities that do not meet specific values or norms. A sustainability focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have a sustainability investment focus. Sustainability-focused investment strategies include but are not limited to exclusionary, positive screening, best-in-class, best-in-progress, thematic, and impact approaches.