In today’s The Stockout, I discuss first-quarter earnings reports from Pepsi and L’Oreal. L’Oreal, in particular, has a lot of momentum of late with shares reaching all-time highs as investors seem to be intrigued by investing in cosmetics as a play on life returning to normal and the burgeoning Chinese middle class. Meanwhile, Pepsi’s results show that consumers are snacking like they are still in lockdown and the company is better prepared than most to handle the current inflationary environment.
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L’Oreal is growing revenue nicely, particularly in Asia. The company’s organic growth in the first quarter was 10.2%, excluding currency movements, which the company estimates to be growth that is 2.5x as fast as the market, which is growing about 4%. Sales in China grew a whopping 38% y/y, and the company cited the province of Hainan as an area of particular strength as many Chinese vacationed there over Chinese New Year. Three of the company’s four segments are growing, and the company has seen a boost in skin care sales as people deal with “maskne” (mask-acne).
Results from Israel and China suggest we may be in for a global “makeup party.” The company suggested in February that we could be in for a “makeup party” akin to the Roaring ’20s when we are more fully past the worst of the pandemic. L’Oreal’s consumer products segment is the only one of its four that is not firing on all cylinders, with makeup making up about 30% of that segment’s revenue. Of course, makeup is still being impaired by a lack of in-person social events in most places, but results from Israel and China, two countries that have managed COVID better than most, suggest the global makeup party may be upon us. Makeup revenue in Israel increased 43% y/y in the first quarter with the luxury makeup segment up 80% y/y. Meanwhile, makeup sales in China are also recovering nicely with the overall market up 19% y/y in the first quarter and with L’Oreal outperforming the market by 800 basis points.
L’Oreal’s supply chain issues were concentrated in the U.S. When L’Oreal described its supply chain issues on its analyst call this week, it read like a roll call of the supply chain issues we have written about heavily on freightwaves.com, such as port congestion, rising freight rates, disruptions from the late-February winter storm, and rising costs for packaging and raw materials. That has led to stockouts of certain items. The fact that L’Oreal had those issues wasn’t a surprise, particularly since some cosmetics utilize transportation capacity with temperature controls, a market that has been particularly tight. However, it was striking to hear those supply chain issues, which have become very familiar, described by a company that was so diversified across geographies because many of the supply chain issues are unique to the U.S. According to the company, its supply chain is functioning largely as it should in most other geographies.
Pepsi’s first-quarter results suggest that consumers haven’t abandoned their snacking habits as they have become more mobile. Unlike its most direct competitor, Coca-Cola, which was hurt by the pandemic, the pandemic’s impact on Pepsi was more mixed; the negative impacts on the high-margin single-serving beverage business were largely offset by positive impacts to its snack business (Frito-Lay) and its breakfast products (Quaker Oats). The question going forward is whether consumers will buy fewer snacks as they spend less time at home. So far, there doesn’t appear to be much evidence of that. Frito-Lay organic revenue was up 3% y/y in the quarter, exceeding its 2% y/y organic growth rate in beverages. It’s also worth watching whether consumers buy fewer breakfast items for at-home consumption, which would impact numerous large CPG companies. Breakfast product sales appears to be slowing with Quaker Oats revenue growing just 1% y/y in the quarter.
Pepsi may have a competitive advantage in an inflationary environment due to its hedging practices. The analyst question I found most interesting from this week’s earnings call suggested that Pepsi has a robust hedging practice in place that is differentiated from most other CPG companies. During past inflationary periods, that has benefited the company, relative to its competitors that would experience more margin pressure. Management seemed to agree that its hedging practices are “structurally elongated,” which gives the company a cost advantage over competitors for a period of time during inflationary periods. Pepsi added that no single commodity accounts for more than 10% of its commodity exposure, which is broad in nature.
Higher costs for agriculture and packaging have been factored into the company’s guidance of high-single-digit growth in 2021 earnings per share (in constant currency) on mid-single-digit organic revenue growth (also in constant currency), which implies there will be little, if any, margin pressure. One factor that has the potential to support margins this year is growth in the single-service beverage business, which is a product category that is usually purchased when consumers are out and about. In addition, the company plans revenue management initiatives; that sounds to me like the company will be increasing prices in line with the market, which will likely see rising prices to reflect widespread inflation in the prices of ingredients.
More directly related to supply chains, Pepsi’s management stated that it is close to having a normal supply chain after recovering from the winter storm. Frito-Lay was particularly impacted by the winter storm because much of its manufacturing and distribution are in the South.
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