The consumer thrives, and so do the stocks

The consumer stocks had a great run over August. No doubt about it, the Aussie consumer has been much stronger than we’d expected, given the higher mortgage rates, and cost of living crisis. It may have hurt smaller, unlisted retailers, but the big ones on the ASX 200 seem to be doing just fine.

Earnings, and the multiple that you put on those earnings, explain share price movements. Below is the forecast 1 and 2 year EPS for a range of companies, and their share prices (R), indexed at 1 over time. At the top, next to the name, you can see the current forward Price-Earnings multiple.

ALL, APE and ARB have done a great job growing earnings. They kept the pandemic gains, essentially, and didn’t suffer from the margin erosion that happened to many other companies (Sonic Healthcare (SHL) for example, had great pandemic gains, but gave it all back) as wage gains and general inflationary pressures ate into earnings. 

However, as you can also see, the share prices have surged well ahead of those earnings, which means PE multiple expansion. For a given dollar of earnings, the market is willing to pay a much higher price. All 3 are trading in mid-to-high 20s, in the bullbar company case (ARB) almost 30x blended forward.

JBH now trades at 24x. It is now the “Coles” (I’d have written “Woolworths” but it imploded) of the consumer discretionary space, and viewed as more akin to a staple than a discretionary name. LOV is on 40x, and the kettle company (BRG) is on 32x forward. These are not low multiples.

Below is DMP, which I included to demonstrate the hubris of paying c50x forward PE for a pizza company during the pandemic (recall it was a "technology company"; the framing used to justify the multiple at the time). It is now on 11x, and is a good example of a consumer preference shift, and an increase in competition (burritos and buckets of chicken). It happens. NCK is on 26x, and WES on 35x.

All of these are good quality compounders (well, maybe not Domino’s, the jury is out on that one, until/when/if Jack Cowin can turn it around) and deserve to have done well. 

For a long time, we'd thought the risk of higher mortgage rates to the consumer would materialise in the form of weaker spending, but, it simply didn’t hurt as much as we’d expected. Places like New Zealand, and Canada (similar to Aus in that they are small, open, trade exposed names with expensive housing markets, with large increases in variable mortgage rates) weakened, and in both cases saw the unemployment rate surge, and consumer spending drop, but we skated by, by luck or by skill or by sizeable government expenditure, quite untouched.

Still, we think, for most of the consumer names, that their multiples are higher than is reasonable for us to pay.

Mind you, we own a lot more companies that are trading in the 12-20x bucket, stocks with modest earnings growth, that have enjoyed no PE expansion, and are having to get by more or less soley on that earnings growth. 

Overall, the whole market PE has expanded, over the last few years its gone from 15 to 20x. The industrials ex banks multiple is closer to 22x. That’s what’s driving the gains, to 9000, or so, for the index. And, we should note, these gains have occurred even as ASX 200 earnings have been marked down.

There’s no great conclusion to this note, other than to highlight the above dynamics. Perhaps at the very least it would seem that PE expansion can’t go on forever, but even as I say that, I think of HUB or NWL, where the PE got to 70x, or COH where it got to 48x. Wesfarmers has, after all, got to just under 40x. 

So, perhaps not forever, but they can certainly double, and they can certainly keep expanding for longer than you think.

Market volatility has been extreme; I think the 6th or 7th broker note to hit my inbox has confirmed August as “the most volatile ever, ahead of the now second most volatile period, which was February”.

Perhaps this will make for a stockpickers garden, with ever greater market mispricing on the offer, but first you have to survive, otherwise it is less of a garden and more of a graveyard.