FMCG faces structural change as stay-at-home consumption, health & wellbeing and sustainability dominate the strategic agenda. COVID-19 has further muddied the waters.
Whilst most FMCG sub-sectors have benefitted from favourable consumption trends in the initial stages of lockdowns there have been some exceptions. Alcohol, for instance, is expected to face a relatively protracted recovery weighed down by on-trade and travel retail exposure.
In either instance, margin expansion is set to become tougher as negative portfolio mix and higher one-off costs prove obstructive. Many corporates have already executed multi-year efficiency programmes, making it harder to squeeze further savings.
Importantly, the pandemic has asked serious questions of yesterday’s supply chain philosophy which prioritised low cost production and stretching supplier terms. Today, corporates are managing disruption risk through localising production whilst supporting liquidity needs of key suppliers. All of these require cash – and there are other claimants in line. Three to be precise:
- Investment: Enhancing digital capabilities across the supply chain
- Acquisitions: Corporates with dry powder may set out to acquire an incumbent, expertise or access to new market verticals
- Shareholder returns: Shareholders have gotten used to a high and consistent level of cash returns
To leverage opportunities ahead, CFOs may first need to revisit medium term capital allocation.
Challenge of Maintaining Shareholder Returns
Study of Total Shareholder Returns (TSR) over fifteen years illustrates that FMCG outperformed other sectors. FMCG sub-sectors feature in the Top Five for at least one component of TSR over the same horizon.
15-Year Average: Top Five Sectors by Category (2004-19)
Recent performance has seen a bucking of this trend with Food & Beverage slipping down the rankings undermined by weaker share price growth. However, the pandemic may fuel a reversal of fortunes. CFOs in more advantaged sub-sectors now have an opportunity to fine tune TSR strategy by investing in drivers of future value across e-commerce, health and sustainability. The challenge will be allocating scarce capital between investment and protecting cash returns still pivotal to the equity story.
This leads us to our next question; how should CFOs meet the growing number of calls on cash?
Impact on Indebtedness
Over the last decade, FMCG corporates have presided over an increase in average indebtedness driven by steady investment, debt-funded acquisitions and in response to activist investor demand for higher shareholder returns, prompting a shift down the ratings spectrum.
S&P Ratings Distribution Over Time (Current1 vs. December 2009)2
Post-COVID, higher investment and potential uptick in M&A create the perfect storm for credit ratings. Corporates with limited debt headroom may need to re-think optimal ratings or consider alternative financing solutions. Sectors like Oil & Gas have tapped hybrid capital markets this year in support of credit ratings. The cost and perpetual commitment of such instruments meant the ‘H’ word was not tabled for discussion in the past. FMCG corporates may be encouraged to similarly diversify the capital structure by refinancing senior debt with hybrid capital.
What Does This Mean for Corporates?
One of the primary levers available to CFOs to release capital remains working capital management. That part is not new. What has changed is the need to extract efficiencies along the entire supply chain.
Cash Conversion Cycle (CCC): 2019 vs. 2014 (Days)
FMCG has relied on Days Payable Outstanding (DPO) but COVID-19 has rendered delaying payments to suppliers unsustainable. Protecting DPO is likely to become a function of more dynamic financing solutions such as Supply Chain Financing with banking partners that have overlapping geographic coverage.
Equally, there is renewed focus on Days Inventory Outstanding (DIO) improvement through predictive analytics and AI that promise to provide data to support inventory optimisation and enable response to market changes in real time. Similarly, for the last piece in the puzzle, Buyer Financing and effective collections management can support Days Sales Outstanding (DSO) performance.
Secondly, the ability to re-orient portfolios to capitalise on growth trends will set sector leaders apart. Whilst many have resorted to pushing ‘value’ brands and expanding e-commerce, the next area of focus will be to address anaemic top-line growth. Corporates with venture capital style incubators and an ability to engage with consumers and communities through crowdsourcing platforms have the infrastructure to deliver innovation-led growth. On the supply side, opportunities for upstream integration or downstream partnerships can enhance overall integrity of the supply chain.
Ultimately, a strategy focussed on margin expansion whilst meeting discretionary cash commitments through internal cash flow can provide financial flexibility and sustainable TSR performance. COVID-19 may have changed the game but the rules of winning are the same.
Source: Standard Chartered Analysis, Company Reports and Presentations, Capital IQ
1 Ratings as of 9th September 2020
2 Includes all corporates rated by S&P in the AAA-C bands across sub-sectors (please see appendix). Analysis includes ratings for main rated entity of larger corporate groups only; we have omitted certain entities, such as subsidiaries or holding companies, where ratings are linked to those of their parent companies.