Consumer brands used to be dependable outperformers. But quality companies that have consistently and reliably delivered compounding growth in value for shareholders over the long term – companies such as Diageo, Unilever and Reckitt Benckiser – have all struggled in recent years.

Their global consumer brands, including Johnnie Walker (Diageo), Dove (Unilever) and Dettol (Reckitt), generate the bulk of their sales outside the UK, so they can even benefit from a weak pound. But their international diversification and high gross margins have failed to deliver for investors, catching out high-profile professional fund managers such as Nick Train and Terry Smith.

In the period that saw the internet bubble bursting a quarter of a century ago and the financial crisis of 2007-2009, Unilever's share price quadrupled, Diageo was up six times and Reckitt Benckiser by almost 11 times from 2000 to 2020. That might sound pedestrian for investors in US technology stocks, but consider that the FTSE 100 trod water over those two decades, a time when blue-chip shares such as Lloyds Bank or Vodafone fell by between 75% and 95%.

Berkshire Hathaway's investment in See's Candies illustrates the economics of consumer brands. In the 1970s Warren Buffett received a phone call asking if he was prepared to pay three times book value to buy See's Candies, an unheard-of multiple for a value investor from the Benjamin Graham school, who would normally look to buy tangible assets with a “margin of safety” of 50p in the pound. Buffett almost dismissed the opportunity as too richly priced, but upon reflection he returned the phone call to do the deal.

The experience worked out well and taught the then middle-aged Sage of Omaha that much of a company's brand value is not recorded on the balance sheet. For a technology or pharmaceutical group, research and development (R&D) costs can be capitalised and recorded as “intangible assets”. Marketing costs, a key investment for consumer brands that often make up between 12% and 18% of revenue, are expensed as they are incurred through the income statement. Accountants take a cautious view of advertising expenses, assuming the costs are effectively wasted, or at least should not be counted as assets.

Analysts can add back marketing spending and capitalise it as an asset on the balance sheet, the same accounting treatment as for R&D. However, they would then need to form a view on the lifespan of that asset, when in reality cherished brands such as Diageo's Guinness maintain their value through the decades. Brands can wither, losing their appeal through lack of care, despite continued marketing spending. Tango, the fizzy drink famous for edgy, award-winning marketing, outselling Coca-Cola's Fanta two-to-one in the 1990s, is an example of the latter. Although Britvic continued to pour large sums of money into marketing, the brand failed to refresh. Organically generated brand value, such as that deriving from Diageo's Guinness, does not therefore feature on the balance sheet, whereas acquired brands and trademarks can be recorded as intangible assets. Examples for Unilever include Horlicks (€2.3 billion), Knorr (€1.8 billion) and Hellmann's (€1.2 billion). The latter two brands have been sold on to US food group McCormick in a $44 billion deal, announced in March this year, to create a group with $20 billion of revenue and an operating margin target of 23%-25%. Unilever's shareholders retain 55% ownership of the combined group and the shares will have a secondary listing in London, while Unilever itself will keep 9.9%.

Just how significant intangible assets can be is illustrated by Diageo's acquisition of the “super premium” Don Papa rum brand for £294 million in early 2023. Only £1 /millionof that was represented by property, plant and equipment, and £6 million by inventory. The brand was valued at £293 million. Just two years later, Diageo wrote down the value of the brand by $287 million. (Diageo had in the interim changed its reporting currency from pounds to dollars.) That write-down is dwarfed in comparison with Kraft Heinz, which announced a $15.4 billion write-down of its best-known brands in 2019, following a deal backed by Buffett and private-equity firm 3G five years earlier.

Unsurprisingly, many investors take a sceptical view of intangible assets because the value can disappear from the balance sheet at the stroke of a pen and management can be slow to write down the value of acquired brands. Casamigos, the tequila brand acquired by Diageo from George Clooney and others for $1 billion, saw an organic sales decline of 25% this year, but so far there has been no write-down. Yet the power of some brands to keep generating cash flows was demonstrated by this year's 12% sales growth of Guinness.

Struggling to keep pace with price rises

Around the time of his See's Candies deal, Buffett had a headache with his original Berkshire Hathaway acquisition. While See's was demonstrating pricing power in an inflationary environment, Berkshire itself, the textile factory based in Berkshire County, Massachusetts, had tangible assets such as machinery that were obsolete. To continue to generate cash flow, Buffett had to keep funding capital expenditure (capex) in new equipment, despite knowing he'd fail to achieve an acceptable return. It's all very well owning factory assets as inflation rises, but at some point the machines need to be replaced at a price greater than the original cost. Depreciation policies, which assume a finite useful life, implicitly assume that replacement costs don't increase with inflation. Thus Berkshire's tangible assets were a drag on returns, while the intangible assets, the See's Candies brand, unrecognised by the bean counters, was paying for itself many times over.

A second attraction of consumer brands is that they tend to report high gross margins (more than 60% in the case of Reckitt Benckiser and Diageo, just below 50% in the case of Unilever). A buttress against rising inflation is a relatively low cost of goods sold (CoGS) – making things for 40 and selling at 100 – meaning that a 10% rise in CoGS has much less impact than upon a group with lower margins. All three groups have been reporting stable gross margins, passing on rising input costs to consumers. The trouble has been revenue growth that has struggled to keep pace with inflation.

By contrast, supermarket groups Tesco and Sainsbury's, with gross margins below 10%, have seen their share prices do unexpectedly well in response to inflation. Although low margin, they have been able to pass on the rising cost of essential items to shoppers, with many consumers favouring supermarkets' own brands. In the 1970s these own brands were synonymous with low quality and cheapness, but recently supermarkets have become more sophisticated at marketing their own-label alternatives. Across the largest six markets in Europe, supermarket own-label brands are growing faster and have reached a 50% share of the grocery market.

The supermarkets have been winners since Russia's invasion of Ukraine, with Sainsbury's up by a third and Tesco up by 90%. By contrast, Diageo has halved in value over the same time period, as other global spirits groups such as Brown-Forman, Pernod and Rémy Cointreau have all struggled. Reckitt and Unilever, which sell everyday items, have also struggled to match the performance of the food retailers.

Some of that performance reflects the starting point, with investors in Reckitt, Unilever and Diageo prepared to pay 20 to 30 times earnings, a premium valuation. Brands are long-duration assets. Arthur Guinness began selling beer in 1759. Before the pandemic, investors were prepared to accept low dividend yields as the discount rate for long-lived assets was low. When “risk-free” UK ten-year gilt yields rose from around 1% five years ago to approach 5.5%, the low dividend yields of consumer staples groups lost their relative appeal.

In an inflationary environment, consumer brands should be able to raise dividends in line with nominal growth. Yet Diageo halved its dividend at the group's December half year to give management more financial flexibility as it struggled with falling sales and a 26% drop in reported earnings per share while burdened with $22 billion of net debt, equivalent to 3.4 times Ebitda.

This points to an essential difference between 1970s inflation and the 2020s version. Although the cause of the inflation was remarkably similar – energy-price shocks from conflict – the level of indebtedness has proved more significant for share-price performance. The corporates themselves are carrying more net debt: Diageo's interest costs have risen 2.3 times from 2022 to 2026. Customers who buy brands are more heavily mortgaged than in previous decades. Unlike in the 1970s, middle-class professionals have faced a severe wage squeeze relative to inflation and many carry far more household debt relative to disposable income. Following the financial crisis, real wages have stagnated in the UK, but those earning close to the minimum wage have seen their earnings outpace those earning the median – the so called “K-shaped recovery”, with the top 10% and the bottom 10% seeing gains, while workers in the middle of the pay distribution have been going backwards in real terms.

Thus, despite the expectation that consumer-brand groups would protect investors from inflation, the groups have lost market share and struggled to grow revenue. At €50.5 billion, Unilever's turnover remains below the €51.3 billion that the group reported in 2012. There are signs of recovery. At the first-half results in June, the group reported 4.8% underlying sales growth, and at £49 per share the group trades on a price/earnings (P/E) ratio of 16.9 times December 2027 forward earnings and an EV/Ebitda of 12 times the same year. That includes the food brands, with the McCormick deal expected to complete next year.

Some consumer brands groups have ‘lost the plot’

Some of the consumer-brands groups have also become unfocused and inefficient. Dave Lewis, the new CEO of Diageo, is targeting $1 billion (or 12% of administrative expenses) of annual savings and is aiming to reduce waste, duplication and inefficiency. In his 2021 letter to investors, Terry Smith questioned whether Unilever had “lost the plot” as management pondered the broader purpose of Hellmann's mayonnaise, trying to convince us that buying the condiment was a step towards sustainability and environmental friendliness.

Unilever responded to the criticism by restructuring its portfolio. First it demerged Magnum Ice Cream into a £9 billion spin-off, then combined its food brands with McCormick in the US. At its first half results in June, Magnum reported organic sales growth of 4.7%. The group trades on a P/E ratio of 16 times December 2027 forward earnings and an EV/Ebitda of 9.2 times.

Brands, by their nature, attempt to create a feeling of association, that they stand for values consumers identify with. This association should mean a brand occupies a place in the collective consciousness so a shopper feels good choosing their ice cream on criteria other than price. Yet as brands become more global and management fear offending anyone, they become anodyne. Reckitt Benckiser defines its purpose as being to “protect, heal and nurture in pursuit of a cleaner, healthier world”. Diageo says its purpose is celebrating life. Perhaps they're losing their edge?

Aside from existential angst over purpose, consumer brands have also created their own problems, not least with poor-value acquisitions. Reckitt is facing legal problems in the US over its infant formula feed. In March 2024, an Illinois state court jury awarded $60 million to a plaintiff. In June this year, the court overturned this verdict and ordered a re-trial. It remains unclear what the final liabilities will be. Management impaired £5 billion of goodwill from the Mead Johnson Nutrition acquisition in its 2019 fiscal year, primarily due to increased competition in China and weaker Chinese market growth, followed by further large impairments in 2023 and 2024 related to the infant formula specifically. Reckitt's acquisition of Mead Johnson for $16.6 billion (at the time £13 billion) in 2017 was an “unforced error” and represents one of the worst UK corporate acquisitions since Royal Bank of Scotland's bid for ABN Amro.

Investors must tread carefully

Investors have long accepted that hubristic bank management can make foolish acquisitions at the wrong point in the cycle. However, consumer-brand groups that sell household products and over-the-counter treatments such as Strepsils and Nurofen should not be causing investors headaches. Reckitt's first-half results in June 2026 showed that goodwill and intangible assets on the balance sheet stood at £15.9 billion, almost three times the group's shareholders' equity of £5.7 billion. Net debt stood at £9.4 billion (2.5 times adjusted Ebitda). Reckitt reported like-for-like revenue growth of 2.6% at its first-half results in June, below the level of inflation. The shares trade on a 15.2 times P/E based on 2027 forward earnings, or 11 times the same year's EV/ Ebita. Unlike Buffett's purchase of See's Candies in the 1970s, it has been the “goodwill” from the acquisition of Mead Johnson that has caused problems. That said, even Kraft-Heinz, backed by Buffett a decade ago, has seen its shares fall 70% since 2017. Investing in consumer brands can trip up even the best investors.

The case for buying Diageo

Diageo, owner of the Johnnie Walker whisky, Smirnoff vodka and Guinness brands, as well as of around 200 others, has seen its rating go from above 30 times P/E during the pandemic to 13 times now. Some of the exuberance five years ago was driven by a rise in demand from households stuck at home, which saw sales jump around 40% to £15.5 billion in the two years of the pandemic to the June 2022 financial year.

This was not sustainable, and sales are now forecast to remain below the $20 billion (£15 billion) level until the June 2029 financial year. Some of the derating has been driven by fears that GLP-1 weight-loss drugs will also reduce alcohol consumption. However, Diageo’s stalling revenue growth predates the advent of these drugs. Between 2013 and 2018, sales flat-lined. Management responded by suggesting that although alcohol consumption was on the decline, drinkers would pay up for quality – the trend towards so-called “premiumisation”.

Certainly, “Generation Z”, those born between 1997 and 2010, are drinking less. Yet premiumisation was a strategy that might have appealed to management and high-earning fund managers, but not to middle-class customers. Perhaps those who sit in the top half of the “K-shaped recovery” are out of touch with the challenges that consumer-brands groups’ customers have faced.

Effectively, the investment case in Diageo has shifted from being that of a “quality compounder” to becoming a classic turnaround story, with the new chief executive “kitchen sinking” his first set of results. In November last year, Diageo announced that Dave Lewis, former boss of Unilever and well regarded for his turnaround of Tesco, would become CEO from the start of this year. Lewis has wasted no time, first cutting the dividend in February, then hosting a Capital Markets Day (CMD) in August. At the CMD, management presented targeted cost savings of $1 billion per annum from group overheads, back-office operations ($850 million) and supply-chain efficiencies ($150 million). Results for the financial year to June showed that organic sales were down 2% across the group, and down 8% in North America. Management expects that negative trend to continue in North America, but the medium-term group target is for low single-digit organic sales growth.

Management hopes that its ready-to-drink (RTD) offerings – that is, pre-mixed gin and tonics and the like – could deliver growth and appeal more to younger generations. It is also walking back from the premiumisation strategy and will now put a greater emphasis on value brands to remain relevant to customers who are feeling squeezed.

Diageo’s shares are trading on a 13.3 times P/E based on June 2028 forward earnings or ten times EV/Ebitda the same year, well below historic averages. The yield is 2.5% as the dividend was cut to $0.50 (or 37p) in February, although the full-year dividend is now covered three times. The shares are down 60% from their peak in 2022, but have begun to recover this year. They are a buy.

Bruce owns shares in Diageo

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