It’s been rather difficult to find many defensive shares as of late. I do believe the market is rather bearish at the moment with some shares being punished heavily on bad news, and some sectors such as Retail finding things incredibly difficult. And this is reflected in the valuations of companies: on average, the Consumer Defensives sector is one of the more expensive ones on a price/earnings basis, only being outdone by Technology and Utilities. This comes as little surprise to me, as investors are either willing to pay more for something with decent prospects of growth (such as technology) or a greater certainty of earnings (such as utilities).
Some consumer defensive firms can offer a little bit of both; the trouble is getting them at a good value price. Associated British Foods was one of them, however the price having advanced almost £4 off the £24ish bottom I do believe that is a fair price for it. Another problem is that there are relatively few firms in this sector, especially if you are wanting to purchase mid or large-cap shares. The tenth biggest (by market cap) is Sainsbury’s; and that is outside of the FTSE100. By the time you go outside the top 20, the market cap of firms is less than £1bn, so there isn’t a great deal of choice.
The reasoning can be fairly simple. When disposable income is scarce, the list of human wants goes down. Therefore the range of things that might qualify as being suitably defensive is quite narrow: household products, foods and so on. Some of what can be considered defensive is arguably in structural decline such as tobacco, and potentially sugar and soft drinks. The rest have large economies of scale and large barriers to entry.
So on to PZ Cussons. This is a share that has had quite a battering recently. It warned on profits in March, which explains the decrease in share price.
The firm is relatively well diversified geographically, with segments in Australia/Asia, Europe and Africa. They own a large range of brands, many of which are well-established.
So what we are interested in, is if the share price decline has come via temporal factors, or one that is specifically embedded in the business.
The headline made no bones about the situation:
Within our interim results announcement in January, we reported that performance in the first half of the year had been constrained by trading conditions in the UK and Nigeria. In our trading update in March we reported that trading conditions in these two markets remained difficult and that we expected profit before tax for the full year to be in the range of £80 million to £85 million.
That’s a fair old decline; previous years equivalent figures were £105-106m before exceptionals. Why were trading conditions difficult?
In Nigeria, whilst higher oil prices have contributed to increased foreign exchange reserves and a relatively stable exchange rate regime, liquidity has not flowed down into the economy. In addition, wage inflation has continued to remain well behind the significant cost inflation of recent years, resulting in consumer discretionary income under pressure with subdued buying levels.
As a result, the usual peak season uplift has not materialised resulting in volumes, prices and margins being impacted across most areas of the Nigerian portfolio.
Africa looks to be a really difficult market. Inflation is running in double digit figures which makes operating a business such as difficult, as costs are constantly increasing, and for many household essentials there are rather entrenched price points. For example, for shower gels in the UK, in my experience I would expect them to cost £1. There are always several on offer at this price. Their overall margins are healthy: consistently over 10% but this is an average of very large margins in the Europe and thinner ones elsewhere.
The initiatives they have planned seem rather conservative: to optimise overheads, reduce packaging, evaluate the portfolio. None seem to be able to trigger any meaningful change in results, with the largest unwritten factor being sitting in hope that conditions improve.
Could this be a good investment?
There are a few things to like about the company. I do believe that the consumer products such as the ones they manufacture are quite durable. Whilst many have specific price points and consumers have no qualms about switching to another product (ie shower gel), overall there is a strong resistance to switch to generic products. Clothing is a sector where someone may choose to spend £3 instead of £5 on a t-shirt; but I see it as difficult for generic branded shower gels to make massive inroads into the market.
Debt has been rising, but at £191m they are not heavily indebted. They are consistently profitable. Exceptional items seem to have hurt them over the last few years, and periods without any of these would make the case for investment look much stronger.
One of the biggest attractions is the dividend here: it has been well-covered in recent times and has increased modestly for an astounding 44 years: one of the best records going.
Potentially they could be a takeover target; or some of their brands could be sold. Some brands potentially could be leveraged into other countries.
A decline in trading conditions world-wide could hit PZ very badly. With consumers being squeezed more and more there may be no choice but to cut prices, which reduces profits further. It can be particularly difficult to raise prices again for some of their products. Perhaps that is in evidence already: revenues have decreased over the past 5 years.
I would be inclined to believe that there is some kind of symbolic gesture attached to the dividend policy; a change to this may see institutional investors leave. At present there doesn’t seem to be any reason why increasing dividends cannot continue, but it goes without saying that if profits continue to decrease this policy will put under pressure.
On a technical note this appears to be a bit of a falling knife. 300p was a historic resistance level but we are well through that now, and the shares are at the lowest point for over 8 years.
It’s certainly possible that the price could decline another 15% but I feel potentially there is a good recovery play here with bad news being priced in.
Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.