A stomach for staples

Consumer goods giants shield their defensiveness

When economies are coming apart at the seams, defensive stocks come into their own. Food and household goods giants like Unilever and Nestle - which both reported first-quarter sales on April 14 - are having such a moment. Both currently trade on a forward price-to-earnings multiple that is around a third higher than the 10-year average. Being defensive isn't easy when almost everything is heading south. That's where dividends help.

Unilever's 4.7 per cent sales growth and its Swiss rival's 3.9 per cent hike in the past quarter were driven mostly by selling more stuff, rather than pushing up prices. That's not exactly a bad thing. Volume growth is one of the most critical numbers for any consumer goods company because it shows there is underlying demand for the products. Besides, price increases tend to hinge on commodity costs and exchange rates. Over the past 25 years, Unilever's average annual pricing growth in emerging markets of four per cent has been pretty much cancelled out by currency moves.

As long as emerging market consumers keep getting broadly richer and more interested in products such as fancy washing powders, the likes of Unilever will do well. But their defensiveness can be overstated. The Anglo-Dutch group is suffering from falling demand in some countries, like Argentina. In the United Kingdom, aggressive discount retailers are pushing down prices. Keeping volumes rising against the odds costs money. Last year the company led by Paul Polman ploughed two-thirds of the gains from cutting costs into increased spending on marketing and branding.

Dividends are the insurance policy against these troubles. Unilever just upped its quarterly payout by six per cent, giving its shares a dividend yield of over three per cent. In strict financial terms, that doesn't affect fundamental value. When a company's returns on invested capital are in double digits, as Unilever's are, the cash is probably worth more in the corporate till. But as fixed income investors have wandered into equity markets in search of relatively low-risk returns, that logic has gone out the window. A steady payout can probably support valuations at even these elevated levels - at least until the actual defensiveness of selling deodorant and fabric softener kicks in again.