Consumers are slow to embrace the decline in inflation due to the cumulative effect of previous price rises.  During the peak of the inflationary cycle, many consumers shifted to lower-priced private label alternatives to their branded counterparts. While price increases protected and fueled strong topline growth, many companies--even the historically strong and ubiquitous brands--have seen their volumes decline over the past several quarters. Since the ability to raise prices further is curtailed for many consumer product companies, they are doubling down on their pursuit to regain their volumes.

The Consumer Outlook Is Mixed Due to Diverging Economic Narratives

Disinflation has yet to register with consumers in the eurozone.  The gap between perceived and measured inflation could partly explain European consumers' spending restraints (see chart 1). According to the European Commission's consumer survey, the benefits of disinflation have not yet translated into positive consumer sentiment in Europe. In our view, this is mainly due to the visible cumulative effect of the price increases mainly over 2022 and 2023. However, the lower interest rates, coupled with a robust labor market and an increase in promotions, bode well for spending over the coming quarters, as the fall in inflation should start to register in consumers' minds.

Chart 1

We estimate an annualized consumer spending in the U.S. of 3.5% for third-quarter 2024.  This would be the fastest growth in personal consumption expenditure since first-quarter 2023. Yet we expect U.S. consumers will likely rein in their spending over the coming quarters since there are signs of the labor market cooling. Furthermore, real income growth has lagged real spending growth since the middle of last year, the household savings rate is at a two-year low, and delinquency rates for credit cards and autos continue to increase above pre-pandemic levels.

Consumer spending in China remains subdued.  The property market woes continue to dampen consumer confidence. The recent stimulus measures may take some time to ripple through and may not fully succeed in lifting consumer spending. That said, solid domestic demand growth and consumer spending in other Asian emerging economies, such as India, Philippines, Vietnam, and Indonesia, supports larger consumer multinationals' growth prospects.

Volumes Remain Anaemic Even As Companies Rein in Price Growth

Volume growth is a critical metric to gauge the underlying demand and the ability to expand market share independently of price increases. Over the medium term, volumes will play a more important role in driving organic growth, compared with the recent price-led growth.

We analyzed price and volume trends between January 2022 and June 2024 in Europe, the Middle East, and Africa. The sample included 20 leading rated companies that operate in the branded nondurables and staples segments across five subsectors (see chart 2).

Chart 2

Consumer goods companies' price increases from 2022 translated into lower volumes, mainly over 2023. In our analysis, volumes declined across all sub-categories in 2023, compared with 2022, except for a nominal increase in the nonalcoholic beverages segment. Even large multinationals with diversified global operations and exposure to emerging markets were not immune to a decline in volumes.

Even though the alcoholic beverages sector recorded one of the highest median price increases over 2022-2023, volumes increased in 2022, largely due to the successful premiumization strategy. However, as prices continued to rise sharply in 2023, even the large global companies in the sector--Anheuser-Busch InBev S.A./N.V., Heineken N.V., and Diageo PLC-- reported a drop in volumes. High prices, combined with the secular decline in combustible cigarettes and competition from new generation products, intensify the volume pressure on global tobacco companies. British American Tobacco PLC and Imperial Brands PLC reported a volume contraction in cigarettes in excess of 5% in 2023 and first-half 2024.

Reflecting the essential nature of food products, volumes declined by only 0.4% over 2022-2023, for the rated companies in our sample despite them increasing prices by around 8% over the same period. Due to higher price elasticity and lower food inflation, volumes rebounded by 2.0% after the cessation of price increases in first-half 2024. That said, smaller private-label food manufacturers continue to face margin pressure from continued rise in labor costs and limited bargaining power with large supermarket chains and discounters.

Mix Effects Are No Panacea

In addition to prices and volumes, mix effects are an important topline component for consumer goods companies. Yet the complexity of quantifying and reporting the effects of a changing mix limits disclosure and reduces visibility. In fact, many companies do not report mix effects separately, while others combine their reporting of mix effects with price or volume.

Mix effects tend to be more substantial for diversified consumer product companies and sub-sectors, such as packaged food, beverages, consumer health, and personal care. While geographical and customer diversification are key, the benefits of mix effects are most visible for premium and higher-margin products that boost commercial capabilities.

Several companies, most notably in the packaged food sector, have reorganized their product portfolios, discontinued lower-margin stock-keeping units, and withdrawn large-pack products in favor of attractive smaller packs, which provide higher margins and are more characteristic of premium ranges. This has led to a self-induced volume decline that will reverse once consumers become used to the new products.

Tough Competition Between Brands And Private Labels Will Persist

High inflation increased the appeal of private-label products across consumer categories.  According to Circana, unit market shares and dollar market shares of store brands in the U.S. reached all-time highs in first-half 2024, at 22.9% and 20.4%, respectively. The growth rates of national brands and sales in most categories in the U.S. increased over the 52 weeks through June 16, 2024.

The store brands of large incumbent national retailers in Europe have historically had a higher market share than their counterparts in the U.S. Data from Statista show that private labels accounted for more than 38% of fast-moving consumer goods (FMCG) sales in first-quarter 2024, up from over 31% in 2018. In contrast, the market share of private labels in China and India is estimated at less than 5.0%, significantly lower than in Europe and the U.S. That said, the rise of modern retail chains, especially in India, will inevitably increase market shares.

Price promotions will play an important role as retailers and brands ramp up their commercial initiatives to protect volumes and differentiate themselves from private labels.  The price gap between branded and private-label products narrowed considerably during the recent period of high inflation. Private labels operate at lower margin thresholds and have more flexibility to cut prices, compared with brands. While input cost reduced for most products, prices for cocoa, milk, sugar, and packaging, as well as labor costs, remain high, which disproportionately affects confectionaries and private-label manufacturers. Higher costs will impede their volume growth and lead to more open book pricing negotiations between manufacturers and retailers.

A Circana's study, which covered more than 175 FMCG categories and 2,000 product segments across the six largest European markets this year found that brands and retailers increased price promotions by 15%, compared with 2023, to boost volumes. In Europe, more than one-fifth of FMCG are now sold on promotion, according to another Circana study. At the same time, private-label promotions increased by 36% in hypermarkets and 25% in supermarkets. Based on the ongoing shift toward private labels, we expect retailers will continue to up their game and challenge branded consumer goods companies across many categories. Apart from offering lower-cost alternatives, retailers continue to invest in the quality and depth of their store brands across higher-margin categories, including organic, plant-based, and pet food.

Emerging Markets Will Drive Growth As The West Nears Peak Volumes

Large consumer markets in Asia, Latin America, and Africa offer more growth opportunities than their Western counterparts.  Unlike branded consumer product companies in the U.S and Europe--which are home to the largest and most competitive consumer markets globally--the faster-growing developing economies of India, Brazil, and Indonesia offer significant market expansion opportunities for branded FMCG and discretionary products. We expect consumer goods companies with an already established presence in these countries will scale up their operations, expand into adjacent categories, and increase their market penetration.

Consumer companies in emerging markets will benefit from an expanding middle class, urbanization, younger demographics, and rising disposable incomes.  Additionally, the rapid growth in ecommerce, especially in Asia, enables branded consumer goods companies to tap into new markets through the less capital-intensive and more profitable direct-to-consumer channel. Exceptions include China, whose sizeable consumer market struggles with weaker sales due to low consumer confidence, and Russia, with an exodus of Western consumer multinationals. Euromonitor data suggest that median volume growth in consumer product categories such as staple foods and beverages--including soft, hot, and alcoholic drinks--will be more than twice as high in Asia-Pacific, Eastern Europe, Latin America, the Middle East, and Africa than it is in the mature markets of Australasia, North America, and Western Europe (see chart 3).

Chart 3

Western multinationals continue to face execution issues when scaling up their operations in emerging markets.  Fragmented supply chains and diverse distribution infrastructure creates logistical hurdles. Additionally, Western multinationals face growing competition from local market players that offer similar products, which cater specifically to local consumer tastes, often at more competitive prices. While global brands and premium ranges continue to increase their market penetration, most consumers in emerging markets remain very price-conscious. This, together with exchange rate volatility, means margins in emerging markets can be tighter, despite lower labor costs. Additionally, Western companies must adapt product ranges and pricing categories to appeal to a more diverse consumer base in emerging markets. In our view, this requires global multinationals to be more nimble and scale up their execution capabilities to fully realize the growth promise of emerging markets.

Multi-Pronged Approach Is Key To Sustainable Volume Growth

While we do not expect that list prices for branded products will reduce meaningfully, consumer product companies and retailers will increase offers and promotions to improve the price perception and remain competitive. Since many retailers, especially in Europe, operate with thin margins, they will have to rely on consumer product companies to fund most in-store and ecommerce promotions. Pricing and promotions alone, however, will not be sufficient to boost volume growth. Consumer goods companies will have to adopt and execute a range of strategies to appeal to discerning and value-driven consumers (see chart 4).

Chart 4

Faced with weaker demand as a result of high prices, many companies have dialed back on premiumization. Yet brands continue to invest to differentiate themselves from peers. Several rated companies have budgeted for a step-up in capital expenditure to support ongoing innovations and enhance product features, quality, and packaging.

Several diversified companies aim to exit lower-margin segments, which are characterized by high operating costs and market competition. For instance, Unilever PLC has been investing in its beauty and personal care segments, while undertaking a series of disposals over the past few years. Among others, it sold its spreads and tea divisions and announced its intention to exit the ice cream business.

As competition remains intense, companies will deploy gross margin gains from lower input costs and carryover pricing gains to strengthen brand equity. Cross-brand collaborations and celebrity endorsements are gaining in popularity, with digital marketing significantly outpacing traditional advertising channels. This, together with the rapid growth of retail media, supports consumer product companies in targeting their outreach and provides a plethora of actionable first-party data about consumer preferences and buying behavior.

Decrease In Rating Actions Reflects Strong Resilience

Rated consumer goods companies have withstood extremely tough operating conditions over the past few years.  They demonstrated their resilience to the COVID-19 pandemic, supply chain disruptions, and high inflation. So far, geopolitical conflicts have only had a limited effect on global supply chains. While freight rates remain elevated due to the Red Sea crisis--which necessitates the rerouting of cargo ships and extends the transit time by 30%--consumer goods companies and retailers are gradually adjusting to the current situation.

Credit quality remains sound.  Year to date, the number of downgrades of global consumer goods, commodity foods, and agribusiness companies has been low at 8%, with no fallen angels and most downgrades occurring in the speculative-grade universe. That said, we consider that the ongoing pressure on volumes and pricing constraints can limit operating and financial flexibility. A high 20% of consumer goods companies globally are on a negative outlook, with almost 50% of companies that are rated 'B-' and below on a negative outlook. Aligned with our expectations of a modest improvement in the consumer outlook, negative bias in Europe is slightly less pronounced than the global average, at 16%.

Consumer goods companies will have to continue to balance their investment priorities.  Capital expenditure budgets are constrained because of wide-ranging plans to enhance product portfolios, restructure, and invest to improve operations and supply chains. Despite our expectations of higher restructuring spend and investments, the ability to generate substantial free cash flows--a longstanding feature of large, investment-grade consumer goods companies--will continue to remain strong. Many large investment-grade global multinationals continue to allocate a significant part of their free cash flows to shareholder returns through progressive dividends and share buyback programs. If volume pressures continue, these companies can moderate their shareholder returns to preserve cash and rating headroom.

Conversely, highly leveraged companies with weak and vulnerable business risk profiles--account for about 30% of the globally rated consumer product companies--tend to have less bargaining power with suppliers and services.  These companies remain susceptible to volatility in their operating performance, strong competition, tough execution, and geopolitical escalations. Accordingly, we expect these companies will have lower financial flexibility to cushion against the stress of operating in a highly competitive environment.

Related Research

• Industry Credit Outlook Update: Consumer Products, July 18, 2024
• Sector Update: Sportswear: Robust Growth Prospects Amid Intensifying Competition, June 25, 2024
• Credit FAQ: Unilever Streamlines Its Portfolio By Separating Its Ice Cream Business, April 16, 2024
• SLIDES: Consumer Goods 2024 Outlook: Carryover pricing supports margins, volumes stay subdued, March 11, 2024