Standard Life Investments

Published Article

Investment Week - US Equities

US equities: Getting the price right


Selected consumer-facing businesses are managing to thrive, provided they can sustain their profit margins and also entice price-conscious customers.

Fizzing with potential

One of the most significant challenges confronting consumer-facing businesses in the USA has been their capacity to pass higher raw materials costs on to their cash-strapped customers. Attempts to digest these costs have inevitably hit companies’ profit margins, even if absolute sales volumes have remained relatively robust. Against this backdrop, selected value can be found with domestic staples firms which are gaining market share while also improving profitability. In the soft drinks industry, the biggest two players, Coca-Cola and PepsiCo, appear to have signalled an end to industry-wide 'pricing wars'. This reflects their acknowledgement that price cuts are margin destructive and will not necessarily lead to market share gains since competitors will inevitably also lower prices when discounts are implemented. This stronger pricing environment looks set to prove positive for beverages company Dr Pepper Snapple, which may also benefit from its company-specific cost-cutting programme.

Corporate restructuring has already secured valuable savings which have more than offset cost inflation and higher spending on marketing. Moreover, Dr Pepper Snapple looks set to benefit from its stronger focus on the domestic market than some of its larger rivals. The US customer base is viewed as likely to prove more resilient than European consumers, in particular, and Dr Pepper Snapple has been winning market share at home. This is one example where the company's ongoing margin improvements alongside its volume gains have yet to be fully appreciated.

Consumers opt for austerity chic

While the broader retailing climate remains challenging, selected retailers are continuing to grow their businesses, particularly those focused on price-conscious consumers. Stock-specific names where we are finding value include TJX Companies, the world's largest cut price retailer whose formats include TJ Maxx in the US and TK Maxx in Europe. Demand for the TJX Companies’ offering (designer labels clothing and household goods at steeply discounted prices) appears to be being supported by a long-term shift in the clothes buying behaviour of female consumers in particular. In an environment in which budgets are tight, women are tending not to buy items that they wear only at work or only for leisure, resulting in less obvious delineation between business suits and casual clothes.

This trend has benefited retailers able to provide an affordable but fashionable offering, particularly those with strong supply chain management which ensures that fashion-led items can be despatched quickly to meet customer demand. TJX Companies has been investing heavily in its supply chain, which is expected to deliver higher turnover from leaner inventories. The company is also continuing to grow internationally, with a significant number of new stores planned for the UK, Germany and Poland. The European operations are currently less profitable than their North American counterparts, but the gap is narrowing and margins are expected to progress towards North American levels over time. In our view, the broader market has yet to recognise the full benefits of TJX Companies' supply chain initiatives or its increasingly profitable geographic expansion.

In a similar vein, auction website eBay has been consolidating its position as a shopping destination of choice for trend-led as well as price-focused consumers. Sales growth at eBay has been accelerating, with mobile usage proving an increasingly important driver of growth. Mobile shoppers using eBay apps spend proportionately more on the site than those who shop via 'traditional' desktops. This is probably because such apps route shoppers direct to the eBay site, ensuring that they are less likely to browse alternative sites. Our analysis suggests that eBay's share price does not fully reflect the sustainability of its stronger shopping revenues or the continuing expansion of its PayPal payment mechanism on to mobile phones and into other retail formats, including store points-of-sale.

There are a wealth of investment ideas for stock-pickers in US Equities in companies where strong growth opportunities are not yet fully reflected in the share price.

Euan Sanderson, Senior Vice President, US Equity Operations, Standard Life Investments

First Published in Investment Week on 23rd October 2012