Will an Emerging Market Slowdown Crush Consumer Staples Stocks?
Oct 5th 2013 9:00AM
Updated Oct 5th 2013 9:02AM
The emerging markets are becoming increasingly important to the financial fortunes of many companies, particularly those within the consumer staples sector. As growth in the U.S. and Europe stagnates, global consumer giants have focused their attention on emerging economies. As these countries develop at rates that far exceed growth from more established nations, millions of new entrants into the middle class mean millions of new potential customers for consumer staples juggernauts.
However, a disturbing revelation in recent weeks may prove disastrous for the biggest consumer staples giants, including Unilever , Procter & Gamble , and Colgate-Palmolive . Emerging market growth is now in question, and if there's about to be a slowdown, it means pain across the board for global staples conglomerates.
Trouble brewing abroad
In a surprise move, Unilever recently issued a profit warning, advising investors that third-quarter sales would likely fall short of expectations. The reason was clear: Emerging market sales are losing pace. Furthermore, many underdeveloped nations are seeing high inflation as a result of devaluing their currencies. Price increases are not likely to keep pace with inflationary pressures.
Unilever now expects between 3% and 3.5% overall organic growth in the current quarter. This is well short of analyst projections, which previously called for at least 5.5% organic growth. Blame rests squarely on its emerging market segment, which will only grow at approximately 5% to 6% this quarter. This falls significantly short of the double-digit growth rates seen in recent quarters.
Procter & Gamble is at risk here because it generates about 40% of its sales from developing markets. The company is succeeding there, and the last thing it needs is a slowdown, given the frustratingly slow growth in the United States. P&G realized 8% organic sales growth in its top 10 developing markets last year, but that momentum is in jeopardy if international growth slows.
This may have a pronounced effect on Colgate-Palmolive, which generates more than half of its revenue from the emerging markets. Colgate has made emerging market growth a high strategic priority, which proved a wise move so far this year. Colgate has realized 11% growth in its emerging market operations this year, but the strategy may backfire should growth come to a screeching halt.
Valuations now a cause for concern
Unilever, Procter & Gamble, and Colgate-Palmolive have produced strong returns over the past couple of years, based largely on rising growth expectations. These stocks haven't been cheap for some time. This hasn't been of great concern to investors lately, since the slow-and-steady growth these companies are known for was fully expected to continue unabated.
However, should emerging market growth fall short and meaningfully depress sector earnings, their lofty valuations are now concerning. Unilever, P&G, and Colgate-Palmolive hold forward P/E multiples of 18, 16, and 19, respectively. Should growth disappoint, these stocks may prove to be downright expensive at current levels.
How will an emerging market slowdown impact dividends?
What won't change, however, are the strong dividend payments that investors count on from these stocks. Unilever, P&G, and Colgate-Palmolive each provide payouts that beat the approximately 2% yield on the S&P 500. Unilever's 3.5% yield leads the pack. Thankfully, those regular distributions will undoubtedly keep rolling in, thanks to the tremendous brand power and business strength of these companies and their products. And, should their stock prices continue to decline, investors will be able to reinvest those dividends at advantageous prices.
One factor investors should take into consideration is future dividend growth, which may be adversely affected by a slowdown in the emerging markets. After all, a company can only raise its dividend if its underlying profits rise accordingly. These companies maintain some of the best track records of paying and raising dividends, so investors should still count on at least moderate dividend growth going forward. But at the same time, double-digit dividend increases may not be reasonable should the economic slowdown in the emerging markets come to fruition.
As a result, while each of these companies represents a pristine business and should definitely not be sold on the news, investors may want to stay on the sidelines before buying at these levels. Stocks can always get cheaper, especially when their underlying fundamentals worsen. If emerging market growth disappoints, investors may be presented with better buying opportunities in the near future.
The article Will an Emerging Market Slowdown Crush Consumer Staples Stocks? originally appeared on Fool.com.Fool contributor Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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