European Consumers Remain Cautious

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with senior analyst Phil Gorham. He just came back from the CAGE conference in London. That's a consumer goods conference for Europe, and he is here to talk to us a little bit about what he learned there and how the European consumer is doing.

Phil, thanks for joining me today.

Philip Gorham: Thanks very much.

Glaser: So let's take a look at some of the big-picture issues that have been affecting consumer goods companies. The first on a lot of people's mind is inflation. What kind of input-cost inflation are lot of these companies seeing right now?

Gorham: It depends largely on which categories they work in. Most firms expect to see low to mid single-digit inflation. That comes from wheat and corn and other traded commodities. A few of which have really ridden up in price over the last few months.

The main issues that these companies face is that they have to somehow try and find a way to pass through those cost increases in order to maintain margins. Either by trying to push those costs through to the consumer or find other efficiencies in the supply chain in order to maintain the margins.

Glaser: How much luck are they having in raising prices right now?

Gorham: It is pretty difficult at the moment, but strikingly at the conference the mood was more upbeat than I have noticed in a long time. Most of the world is improving. Emerging markets, for example, are growing like the financial crisis had never occurred. North America is starting to improve but growth is still quite slow, though unemployment is very important to these firms.

But the real sticking point is still Western Europe. You have got high unemployment. Governments are implementing austerity measures that include cutting some public-sector jobs. So the environment is still tough, but most of the rest of the world is allowing an environment that will make raising prices a bit easier.

Glaser: Let's focus a little bit more in Western Europe. Certainly those consumers have been under siege a lot of ways. Is there any sign that that might be ending, that these consumers are getting back on their feet, or is there going to be a real long haul there?

Gorham: Not really. It looks like a long haul. In certain markets like Spain, for example, unemployment is extremely high. I don't think there will be any improvement there until next year at the earliest. Greece is another example. In the U.K. this month, in fact, in April, we will see the full impact of the government cost cuts there. So, some markets are proving there is a long haul, a long way back for the consumer.

Glaser: So if we think about emerging markets, you said that's an area that was growing really quickly. Is there any differentiation between say Latin America and Asia? Or are we really seeing kind of broad-based improvements in emerging markets?

Gorham: It's largely broad-based. Latin America, in particular, is quite patchy, but the real growth driver for most of these firms is Asia, markets like China and Indonesia are real growth drivers.

Glaser: Now if we think about individual companies, are there any that kind of surprised you at the conference with the way that their outlook is, or is everything pretty much in line?

Gorham: I think most companies were more upbeat than I was expecting. I think there's even been an incremental improvement in mood from the New York conference we attended last month. But apart from that, I think it was mostly in line with what we have been expecting for several months now.

Glaser: Are there any individual stocks that you think look attractively priced today?

Gorham: I think PepsiCo looks quite cheap. It's trading at 14 times earnings, which is too low for a wide-moat firm, with a global distribution framework, and great brand in snacks. I think that if they can implement some turnaround in their drinks in North America, I think we will see upside for the stock.

Glaser: Phil, thanks so much for talking with me.

Gorham: Thanks, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.