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An Analyst's Take: What the Rise of the Private Label Says About Consumer Staples


Looking at the goings-on in America's retail land, the outlook for gross margin for consumer branded companies is pretty ugly.


Editor's note: This is our first column by Ronald Thomas. Ron is a accomplished consumer sector analyst/sector portfolio manager with an outstanding long term stock picking record. He predicted the huge, ongoing retrenchment of the American consumer in late 2005, seeing the subprime mortgage mess as the catalyst. Ron will be writing for Minyanville on an ongoing basis, covering the consumer sector.

The biggest factor in consumer staples right now is the financially pressured consumer and the attendant growth in private label staples. The lack of growth in real income for the US consumer over decades started showing up in the growth of private label food in the 1990-91 recession and then spread to household products and soft drinks. Every year there would be about a .5% to .75% growth in private label units and the end of a recession such as 2001 would not cause any meaningful pullback in private label share.

Even though there has been a one-way ratcheting of private label share through good times and bad there has been no closure in the branded private labels pricing spreads, sometimes referred to as the "gouge gap" by buy-side analysts. The food gouge gap was 28% when I first saw a pricing study in about 1991 and the last one I saw was at about 31% on prices taken about two years ago. The spreads for household products are larger, generally 35-50%, differing by item. Beverages gaps are harder to measure, but are nearer 30% I would guess if end aisles promos are eliminated.

I find it somewhat surprising that these gaps have not changed. Unemployment is officially 9%, but add in under-employment and 14% seems like the better number. The savings rates in Q2 and Q3 of this year were 4.8% and 3.8% respectively, down from the 5-6% range since the 2008 financial crises and below the 8-9% which economists would consider healthy. The pressure from student loan defaults has not yet hit those to-be-affected consumers. There have not been any real tax increases, which are likely coming one way or another. My expectation is that the consumer is still only in the sixth inning of a long-term economic retrenchment. In Europe, which is a big market for many consumer-oriented companies, the retrenchment to pay for the debt crisis is still to hit, and the retirement funds are not near adequate. So, there will be a somewhat analogous retrenchment to the US. And the US and Europe are the two highest margined areas for the consumer staples companies.

Looking at the goings-on in consumer land in the US, the outlook for gross margin for consumer branded companies is pretty ugly in my opinion. Historically, you could read sell-side analysts' reports and they would talk about a hierarchy of goods, where some, such as cornflakes, would be easy to knock off by private label producers, but where others, such as cookies in the food category -- and that holy grail of cosmetics and household products, razors -- would remain untouched by private label. But year-by-year private label shares would start to grow in every product, moving inexorably up the chain to the highest advertised, supposedly most impregnable products.

Looking at what is going on in retailing, there is no reason to believe that private label is slowing up. This situation is a reflection of the consumer situation.

Last year I toured my first Big Lots (BIG). Now I have have been a big bear on the consumer, predicting a huge retrenchment since late 2005, when I made a call that sub-prime mortgages were going to tank monumentally and bring the consumer back to reality. But I was still surprised at what I saw. There were no Coke (KO) or Pepsico (PEP) products in the store. Procter & Gamble (PG) was totally absent, including Gillette. I'm somewhat sure that there were no Schick products as well, and Gillette and Schick are about 80% market share between them. One other big household-products company, Colgate (CL) or Clorox (CLX), I cannot remember which, was not there. To be sure there were other brands there from Unilever (UL), S.C. Johnson and other food brands. But the implication is clear that you can build a retail business without some of the biggest consumables brands. I never would have thought that possible even a few years ago. A few weeks ago I went to another Big Lots and saw some Pepsico beverages, but the same situation in the remainder of the store. A Dollar Tree (DLTR) (more successful operator than Big Lots) store in the same strip center was generally devoid of the same brands as the Big Lots I saw last year.

The biggest square footage grower in retail of any size that I know of is Aldi at about 10%. Aldi is 100% private label. Moving onto more familiar ground, you can look at Kroger (KR), the most successful large traditional supermarket operator, where private label is 34% of units sold. With the food industry at about 21%, there is a lot of private label growth that will likely be coming, even without a shakeout in the industry that would favor the large operators who have the highest private label percentages. Costco (COST) keeps gaining market share and has had the seeming audacity to throw Coke out of its stores during spats with the company. Its most recent new offering that I am aware of is private label toothpaste, simply called Toothpaste, which because of its near cosmetic positioning in consumers minds was once considered to be akin to razor blades in its imperviousness to private label. (The proportion of toothpaste product facings at Costco will be of high interest in the coming year for me.) Oh, and Safeway (SWY) is now employing brand managers for its private label brands.

The rise in commodities prices in the last few years has hit the consumer and the staples companies hard. Staples companies have passed through some of the price increases and found that just about all of their products' price elasticities have been greater than they thought they would be, or at least what they told investors they could expect. Investors have been generally skeptical of putting too much faith in this year's reported earnings, as the companies have been heavily hedged against commodities cost increases, but they will put more faith in 2012 estimates without the hedges.

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