Food/beverage
The author is an analyst for Shinhan Securities. He can be reached at sanghoonpure.cho@shinhan.com -- Ed.
Defensive plays lack luster in unfavorable external conditions
Over the past two years, key investment points for the food/beverage sector have been price hikes, grain price declines, and the subsequent improvement in margin spreads. And this has been underpinned by strong confidence in the fast recovery of food and beverage product sales after price hikes as they are consumer staples. However, such confidence in sales volume growth has been waning in the face of an economic slump following surging inflation. Consumers’ resistance to price hikes typically lasts three to four months, but their resistance to price increases across the industry over the past two years is holding up longer than expected.
Margin spreads have also been slow to recover contrary to market expectations. Prices of some grains have stabilized at lower levels, but the overall cost burden has persisted while the USD/KRW exchange rate remained at high levels. Moreover, the Korean government has recently called on food/beverage companies to cut prices of certain product categories.
Repeat of challenges seen in 2010, will this time be different?
The food/beverage companies are losing their investment appeal with the government’s push for price cuts undermining their pricing power. This reminds us of the challenges they faced in 2010 when business conditions deteriorated under the government’s price cut pressure amid the fierce price war raged between discount stores.
Going forward, we believe focus should be placed on: 1) companies that see steady sales volume growth regardless of price adjustments at home; or 2) companies with high overseas exposure so that they face less pricing pressure from the government. Nowadays many companies’ earnings are driven by overseas businesses, meaning their weakness at home can be sufficiently offset by overseas earnings. Contrary to the domestic market, companies are seeing steady growth in demand in overseas markets and are able to implement regular price hikes. Competition is also less fierce in overseas markets, and efforts to expand overseas sales channels have already incurred all necessary expenses. Companies that achieve an upturn in sales volume growth at home and abroad deserve our attention, not worries.
Focus on sales volume than margin spreads; top picks are Orion, Nongshim
The economy is in the early phase of a recession following the surge in inflation. With domestic consumption likely to remain on a structural downturn for the time being, there is a possibility that companies may see a delay in turnaround of earnings and share valuations. A much-awaited upturn in margin spreads has been pushed back with the government’s call for price cuts adding to the prolonged cost burden. Amid the slowdown in consumption, sales volume growth at home and abroad will be the key point to watch for. We believe companies whose product categories will face a limited decline in demand should enjoy more opportunities than peers. We hold an upbeat outlook for the junk food category which can be a more affordable meal option. We keep Orion and Nongshim as our sector top picks as they show decent performance in terms of prices, sales volume, and costs.