In releasing its third-quarter 2013 earnings earlier this month, Mondelez International (NASDAQ:MDLZ) retreated from its oft-stated goal of growing organic revenue 5% to 7% annually, at least for the time being. Management now forecasts a full-year growth rate of 4%. Over at Anglo-Dutch competitor Unilever (NYSE:UL), "underlying" sales growth, a rough equivalent to Mondelez's organic sales growth, checked in at 4.4% in the first nine months of this year. Procter & Gamble (NYSE:PG), which just concluded the first quarter of its fiscal 2014 year, reported organic growth of 4%, which is actually a step up from its recent annualized trend.
It appears that a new association, comprised of a rare group of giant consumer goods conglomerates, has been formed this year, with modest 4% annual revenue growth being the common membership criterion. Who should the club members thank for bringing them together? Why, the very emerging markets that were until recently pulling them out of their respective revenue doldrums.
The route to membership
Mondelez's biggest current headache comes from what at first may seem a surprising source: the company's $1 billion China business. Mondelez enjoyed rapid growth in Asia in 2012, powered in part by the popularity of products such as its green-tea flavored Oreo cookie in China (the "biscuits" category includes cookies). But biscuits revenue in China has fallen off dramatically in 2013, growing only 2% last quarter. To make matters worse, Mondelez had significantly increased its biscuits inventory in China earlier this year, in expectation of continued double-digit growth. Now it will have to work off its excess inventory -- that's a lot of Oreos.
On Mondelez's earnings call earlier this month, an analyst recalled that China's quarterly GDP growth rate is comfortably above 7.5%, and was curious why in this situation biscuits revenue would decline from double digits all the way to low single digits. The answer to this question is rather complex, but a significant rationale for the decline can be inferred from the following graph:
While China's GDP may be growing at an annualized rate approaching 8%, it is essentially dealing with 2 percentage points of growth rate decline from the peak years of 2010 and 2011. The relatively tamer growth in 2013 marks the first quarters in which Chinese consumers would have begun adjusting wage expectations and discretionary spending habits, as the last six quarters show an undeniable flattening.
A growth-trend plateau in China has different implications than it would in a more developed country. It indicates that consumers with newfound ready money may be joining the economy at a slower rate than before. It's probable that the prototypical Chinese consumer you read about in so many breathless financial articles, the rural villager who now works in a factory in Tianjin or Chongqing or Shenzhen, is acting more cautiously with his or her yuan due to a visibly slower economy. So for a behemoth like Mondelez with a portfolio full of power brands, the strategy of keeping enough product on shelves to meet an ever-increasing volume is no longer valid, and management acknowledged as much in its most recent earnings call.
Unilever has also seen moderating growth in its China businesses. During the company's third-quarter 2013 earnings call, CFO Jean-Marc Huet cited slowing domestic demand in India and China as one of the headwinds the company has faced this year. As for Procter & Gamble, which for now doesn't mind being in a 4% club, its results were achieved despite a flat environment in China.
China offers the largest consumer goods opportunity among emerging economies, but it's increasingly a near-term volume trap, as a host of companies that enjoyed initial success in the 2000s are now rather abruptly faced with suddenly stalling growth. This phenomenon is also occurring in the emerging markets powerhouses of Brazil and India, as well as other, younger regional markets.
Coping mechanism No. 1: Unskewing results through fewer SKUs
Members of the 4% club are facing the new reality with pragmatism. They want to offer a sweetener to investors: increased earnings per share driven by improvements in gross margin. Unilever and Mondelez are both trimming the number of stock-keeping units, or SKUs, in their respective brand portfolios. By doing away with nonessential, nonvalue-added products, and low-revenue versions of popular items, conglomerates can point their marketing, manufacturing, and labor dollars toward the brands and SKUs in those brands that enable sales growth and better profitability. There's plenty of low-hanging fruit to be found, as companies as large and diversified as Unilever can have hundreds of thousands of SKUs associated with their brands. The following wry quote from Unilever CEO Paul Polman in the earnings call captures the idea perfectly:
I actually am in the camp that if you have less SKUs, you can grow better. If you have more SKUs, there are always some SKUs on life support, and you know the National Health Service is becoming pretty expensive.
Coping mechanism No. 2: Revamping the supply chain
Improving local supply chains will also yield margin expansion. Mondelez, which has gained some of its power brands through corporate acquisitions, recognizes that it has multiple opportunities to make a cobbled-together supply chain much more efficient. An example of this upgrade strategy is a state-of-the-art capacity addition at the company's manufacturing facility in Suzhou, China, announced this summer. Mondelez is investing $85 million to double capacity at this plant, which churns out Oreos and Chips Ahoy! for the local market. P&G is building a massive, multicategory plant in South Africa that will serve as a hub for its Southern and East Africa business. For P&G, the object is to cut down product component transport costs by sourcing as much within a specific region as it can -- this also smooths out currency effects on earnings due to the higher percentage of material goods and labor costs that are recorded locally. The companies hope that these investments will also increase their speed from manufacturing to store shelf, resulting in added sales opportunities.
What to expect going forward
This year has demonstrated that revenue increases for consumer goods titans won't come effortlessly. But as Unilever's Polman has pointed out, the International Monetary Fund predicts that emerging market economies will grow at a rate of 4.5% this year. Thus, matching the growth rate of your most promising markets can't be all that bad. Still, investors may want to reset expectations of top-line organic growth for this breed of companies accordingly.
Alternatively, you can opt for a little less diversification of product and invest in Kimberly-Clark (NYSE:KMB). It currently sees no slowdown in emerging markets. As CEO Thomas Falk said recently in a comment regarding its U.S. business, but which applies equally to most of its markets: "Mostly people need diapers and bathroom tissues every day."