Consumer Packaged Goods Join the Digital Revolution

By Berna Barshay

Monday, February 22, 2021
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► I spent last week attending the virtual CAGNY conference…

Several themes emerged as I heard from some of the largest consumer packaged goods (“CPG”) companies headquartered in the U.S. and Europe.

Two things came up in every presentation: the presenter wished we were in Florida, where the conference typically takes place… and the environment we’ve been living in for the past 11 months has led to a digital transformation of their business.

As with other industries I’ve written about, the digital evolution had firmly taken root for CPG companies well before COVID-19 appeared, but the circumstances of the past year greatly accelerated the transformation already in place.

The first area within most CPG companies to be affected by digital migration was the marketing department.

CPG companies are huge marketers. The strongest and most highly valued businesses that make food, beverage, tobacco, and personal and household care products have portfolios of almost universally recognized brands – many of which have been built up over a century or more.

The greatest spoils of any CPG category – from toothpaste to sodas to laundry detergent – often accrue to the top two or three brands, which enjoy superior product placement at retailers and scale benefits in manufacturing, distribution, and marketing.

Brand building has always relied on heavy advertising. TV ads have been used to build brand halos as well as gather awareness for product launches. CPG companies spend a lot on advertising, and CPG accounts for around 8% to 9% of the total U.S. advertising pool. It sits behind only the retail and financial services industries for total spend.

All that spending on brand building seems to have paid off in the past year, as one theme that emerged from dozens of presentations was that trusted, well-established brands gained share during uncertain times. In many cases, this reverses a multiyear trend of share loss to smaller, hipper brands perceived as more “authentic” or lower-priced private-label (retailer house) brands that offer greater bang for the buck.

As with the advertising market in general, CPG has gone digital with its spending – 2020 was the year that digital advertising tipped greater than 50% of the overall ad market.

CPG was initially a little slower than some industries to move online since much of the historical messaging was focused on building brand trust or conditioning an emotional response to a brand… Think of General Mills’ (GIS) Cheerios evoking family with images of breakfast time or Campbell Soup (CPB) associating itself with comfort on a cold day.

While still committed to overall brand building, CPG companies have completely joined the rest of the world in seeking out very precise targeting of consumers…

Digital advertising offers much better certainty than traditional advertising in reaching the specific consumers with a propensity to buy what a company is pushing. Digital channels generally know who you are, where you live, how old you are, whether you have kids or pets, and what websites you’ve visited.

TV programs typically know the general breakdown of their audience by age, gender, and geography. They can guess at the rest… but it’s a much less exact science.

I wouldn’t expect the CPG companies to disappear from primetime – just look at Kimberly-Clark (KMB) using its toilet paper money to memorably advertise its Huggies diapers for the first time this year during the Super Bowl. Even though the company is 43 years old, the No. 2 player in diapers, and generally well-known, Kimberly-Clark expressed confidence this stepped-up investment will pay off for Huggies. However, this move to allocate increased budget to TV will likely prove increasingly rare.

CPG companies have woken up to the fact that it makes a lot more sense to advertise pet food to people who actually have dogs and cats… and not to advertise charcoal to people who live in urban high rises. It may be very Big Brother to think about, but these companies now can guess what you’re going to need, sometimes before you can.

Nearly every company at the conference mentioned shifting their advertising budgets away from traditional channels – primarily TV, but also print and radio – toward digital… and they’re seeing higher returns on their marketing investments as a result.

At food company Conagra Brands (CAG), 80% of its media spend has shifted to digital… and it noted a higher return on investment (ROI) as result. Hershey (HSY), traditionally a huge TV ad buyer, has shifted almost 60% of its spend to digital media… and offered one of the creepier examples of targeting during the conference. During the pandemic, the company directed ads promoting its signature chocolate bars for making S’mores based on which areas saw the sharpest rise in COVID-19 cases, and where more consumers were presumably sticking close to home.

Digital is affecting these businesses in other ways. As with most consumer goods, these companies are selling more online, occasionally through their own sites, but more often through the e-commerce operations of “omnichannel” retailers like Target (TGT) or e-commerce specialists like Amazon (AMZN).

It’s early days for this, and most of these companies only have a single-digit percentage of sales made through e-commerce… but nearly every business saw its online sales grow by 50%, 100%, or more last year.

Certain niches within CPG also are seeing a more rapid e-commerce adoption… For example, Nestlé (NESN.SW) mentioned that almost 20% of its pet food sales happen online now, and its online pet food sales grew 65% last year.

A few companies – pet players Nestlé and Colgate-Palmolive (CL) among them – even mentioned the possibility of going into the digital subscription business. Subscriptions are hot from software as a service (“SaaS”) to streaming… Why not for Rover’s snacks as well?

Digital is also greatly changing the business processes at these companies… from optimizing distribution and logistics through technology to bringing efficiencies to retail relationships through online ordering and inventory management.

Portfolio management isn’t just for stocks… It’s for CPG portfolios as well.

These are very mature and seasoned businesses that tend to have top-line growth that correlates with overall GDP, inflation, and population growth. Most product lines grow in the low-single digits, and the ones that are more in line with consumption trends might put up mid-single digit growth. The ones that are out of vogue might actually shrink – packaged cereal did for years, as people not only ate more breakfasts away from home but also started to eschew carbs and sugar at increasing rates.

For this reason, continued incremental operating margin improvement – usually targeted around 25 to 50 basis points per year – through efficiency and scale is a focus at nearly all these companies. Additionally, most add a heavy dose of financial engineering in the form of stock buybacks to transform meager top-line growth into high single-digit or even low double-digit earnings-per-share (“EPS”) growth.

The other way they position for more growth is through continual portfolio re-shaping – selling businesses that are in secular decline or lacking scale and then making acquisitions of smaller businesses in hot areas with better growth prospects.

This portfolio rebalancing should continue in the future, although the effect of COVID-19 proved a rising tide that lifted nearly every boat in CPG last year. My friend and veteran consumer analyst Faye Landes summed it up well in her Weekly Reading note, which she devoted to the CAGNY conference this past Friday…

For years the presenting companies have been talking about adjusting their portfolios in order to be advantaged, buying companies that make nutrition bars, plant-based items, pet food, juices, etc. Nonetheless for many if not most of them it was hard to offset the at best anemic growth of their legacy brands.

Obviously the pandemic turned some longtime market share losing product lines into enormous winners. The reversal of a decades-long trend towards increasing eating out of home has made the managements of food companies, especially the ones that sell cereal, practically giddy. The craze for pet adoption, with 12.5 million new pets adopted since the start of the pandemic, has been a boon to the companies that have exposure to the pet food sector.

Increased time at home naturally led to more food and drink consumed at home, as well as more garbage and clean-up. More people at home led to the dishwasher being run more frequently and the need for more frequent toilet cleanings.

As Faye noted, the pandemic offered a temporary reprieve for Kellogg (K) and General Mills as cereal demand soared, and a road bump for their divisions that make protein/energy/nutrition bars… a staple of on-the-go life, and a growth category until this past year.

The pandemic wasn’t a boon for every product category, though… In addition to cereal bars, it was a rough year for companies trying to sell razors, deodorant, and condoms. I think we’re all rooting for a rebound in these categories in 2021.

Of course, every company that got a tailwind from the pandemic thinks it received a lift that will prove sustainable… and every company that had a division that was felled by reduced mobility thinks that demand for its forgotten offerings will come roaring back as the pandemic comes to an end. Of course, these can’t both be true in all instances.

Tomorrow, I’ll dive into some of the behavior changes that drove accelerated growth in CPG categories in 2020 and attempt to make some predictions on which trends may have legs and which will prove a flash in the pandemic pan. I’ll also note which companies piqued my interest as potentially the best investments in the sector right now… Stay tuned!

In the mailbag, readers react to my essay on the legacy of Amazon CEO and Founder Jeff Bezos…

Are there certain packaged goods – foods, beverages, household or personal care items – that you found yourself using notably more or less of during the pandemic? Did you find yourself seeking out trusted, well-known brands more than usual during the last year? Are there some product categories where brand matters a lot for you, and others for which it’s less important? Let me know what you think in an e-mail to [email protected].

“I am in complete agreement with acknowledging Bezos’ brilliance in building Amazon into the incredible force it is today in retail and AWS. I do, however, find it disturbing that the working conditions of his 500,000 employees is barely better than that of the auto factory workers prior to unionization and safety laws enacted in the early 20th century. There is also something fundamentally wrong with a man making 867,000 times his lowest paid employee and there is also something wrong with a company culture that does not address its environmental impact especially now that most thoughtful leaders understand the importance of correcting these impacts for the good of the planet. In other words, I do not have much respect for Bezos as a human being which is way more important than being the second richest man in the world.” – Ramona R.

“How many small businesses along with good paying jobs were lost because of Bezos’ greed? What a legacy! No thank you.” – Doug T.

“Berna, everyone is talking as if Bezos has jetted off to space already, but in mind, I can totally see him returning to Amazon like Howard Schultz [of Starbucks (SBUX)] did at some point. Another thing to consider: What if the greatest legacy from Bezos will NOT be even related to Amazon? I suspect there are many things we don’t know about him and there are many things people won’t say about him – until he is really long gone.” – SHL

Berna comment: While I agree with the valid criticisms of Bezos’ legacy made by Ramona and Doug, I actually think his image may improve with his second act… which may be more about advancing society and science than personal gain.

In his departing letter to employees, Bezos mentioned his interests in environmental justice and clean energy, space exploration, and journalism. I guess we’ll see over time whether his second act looks more like that of Bill Gates or Howard Hughes.

“Jeff Bezos was just computer smart, Sears and Roebuck was way ahead of Jeff, just in a different time and place” – Kirk A.

“What has Bezos done for shareholders lately? Limited upside and we’ve been channeling between 3000-3350 for about the last 6 months? Why not a stock split or something that would actually attract more investors? Thanks!” – K.T.

“Hi Berna, Enjoy your letter! I thought the reason Toys R Us went bankrupt was because it was saddled with some $5B+ in debt after the private equity buyout. Even at the end, they had $11B in revenue but were paying something like $400m per year to service the debt.”– Frank K.

Berna comment: I agree that the leveraged buyout (“LBO”) and the debt that came with it was the death knell for Toys “R” Us… But the business was certainly challenged by Amazon’s rise. Amazon’s share gains led to problems for a Toys “R” Us suffering from a heavy debt load. I think a Toys “R” Us unburdened by debt and with great management might have found a path forward, probably by leaning into in-store experiences and heightened customer service.

It would have been hard… but others have managed to survive Amazon, from Best Buy (BBY) to Target. The high debt load made it impossible for Toys “R” Us to take risks, experiment, and ultimately save the business.

Regards,

Berna Barshay
February 22, 2021

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Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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