"Being nervous isn't bad. It just means something important is happening"
- Michael Jordan
If you are a casual reader of the Early Look, you might not know that our 7:45 am research call went live this past Wednesday. I have been the "first analyst" to speak on "The Call" since the firm was founded in 2008 (FYI- all that means is I must be ready before everyone else).
When Keith called on me last Wednesday, the first words out of my mouth "I'm a little nervous!" The great Michael Jordan was right when he said being nervous isn't bad, because something very important is happening at Hedgeye. That's a good thing! Unfortunately, good things don't usually happen in Quad 4!
In the first few weeks of 2022, we prepared for the shift to QUAD 4 (maybe prematurely) by realigning all of our position monitors across our Consumables universe (Restaurants, Consumer Staples and Cannabis). Of our three sectors, Consumer Staples has the highest expected value of any sector in Quad 4.
However, not all companies will enter Quad 4 with the same fundamental outlooks. The changes we made in the position monitors used our internal style factors that we believe are the most important in a Quad 4 regime: Federal Reserve rate hikes underpinning a more robust U.S. Dollar, peaking commodity prices, defensives including value and higher dividend yields, and quality of earnings will outperform high beta, levered balance sheets, and cyclical growth.
Back to the Consumables Grind…
In the later part of 2021, the rapid increase in inflation was a significant headwind for margins in Consumer Staples, making many names great shorts. We see that reversing in the 2H22. A key element of our Consumer Staples Themes call is a significant, positive inflection in margins in a couple of quarters.
CPG companies are experiencing cost increases for everything from labor, packaging, food ingredients, and transportation. Peaks are generally processes, not points. Since food at home is a relatively small portion of CPI, we can have peak inflation while food prices continue surging to new highs. Food manufacturing costs are in the process of peaking while price increases are accelerating, strengthening margins later in 2022. The margin inflection we are modeling for the sector is depicted in the chart of the day.
For Consumer Staples names, we are focusing on a post-Deep Quad 4 scenario in 2Q22. We will be looking for many names in the staples space to see a positive inflection in operating margins in the 2H22 for the following reasons:
- The PPI for food manufacturing peaked in September
- Frozen food manufacturing PPI is peaking with easier comps coming
- Improving supply deliveries
- Peaking COVID-19 cases
- PPI is accelerating for supermarkets and is likely to continue
- Companies are implementing additional rounds of price increases in response to cost pressures
- Fewer discounting and less competitive intensity
- Lower price elasticity in the current environment
- Price increases are accelerating while cost increases look to decelerate
This week, an early sign that we may be correct in our thinking came from the Procter & Gamble (PG) earnings report. The PG earnings report encapsulated several of our investment themes outlined in our Consumer Staples Themes call. Management's implicit expectation for gross margins to inflect aligns with the timing of our margin projections. In our Themes Call, we discussed why the current environment enables the pass-through of price increases to the consumer. We expect the pricing environment to continue in the coming months due to out-of-stocks, lower competitive intensity, less private label trade down, higher demand, and cost pressure.
The balance of our Consumer Staples investment themes are:
INFLATION – While the broader measures of inflation show signs of peaking, food at home inflation remain elevated and is likely to accelerate further. The current environment facilitates passing on price increases by the CPG companies.
PLANT-BASED – Most CPG companies are still in the early innings of R&D investment in plant-based food. The competitive moat from R&D, formulation, innovation, and branding is already shrinking.
SNACKING – Snacking has secular growth drivers as more Americans consume a more significant share of their calories from snacking. Eating at home during the pandemic accelerated the trend.
DIGITAL ORDERING – Digital grocery shopping was 12% of spending in December. Excluding ship, to home, it was 10%. The delivery companies are still battling for scale dominance funded by investors. The lower-margin business makes it nearly impossible for retailers to compete independently. M&A is likely.
WAGE PRESSURE – Unionized companies are relatively less impacted in the near term (a unique advantage), but wage rate pressure will build over time. The pandemic exacerbated worker shortages between government payments, sick days, and fewer seeking work. More strikes will occur, but the absolute level is immaterial in 2022.
Focusing on the Consumer Staples sector, our reshuffled position monitor accounts for international sales mix, exposure by commodity, pricing plans, the elasticity of demand, margin outlook, competitive dynamics, and secular growth trends. While there are many more names we are looking at, in the short run, we added General Mills (GIS), Keurig Dr. Pepper (KDP), and Pilgrim's Pride (PPC) to the long list. We added Anheuser Busch InBev (BUD), a rare Consumer Staples Quad 4 underperformer, to our short list.
If you would like to learn more about my research team's in-depth investing research please reach out to .
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 1.66-1.87% (bullish)
UST 2yr Yield 0.83-1.10% (bullish)
SPX 4 (bearish)
NASDAQ 14,002-15,141 (bearish)
RUT 2093-2175 (bearish)
Tech (XLK) 155.97-167.10 (bearish)
Housing (ITB) 69.13-80.11 (neutral)
REITS (XLRE) 46.64-50.01 (bullish)
Consumer Staples (XLP) 75.61-77.77 (bullish)
Shanghai Comp 3 (bearish)
Nikkei 27,101-28,690 (bearish)
DAX 15,614-16,097 (bullish)
VIX 19.58-27.39 (bullish)
USD 94.65-96.40 (bullish)
Gold 1 (bullish)
Copper 4.30-4.61 (bullish)
MSFT 292-318 (bearish)
AAPL 161-173 (bullish)
Have a great weekend,
Howard Penney
Managing Director
