KXI Is Downtrading Exposed, Discount Insufficient (NYSEARCA:KXI)

The iShares Global Consumer Staples ETF (NYSEARCA:KXI) has been really solid from a price perspective so far this year. But we think that investors in this ETF might be in for a rude awakening. Our house view is that the recession is going to get worse, and consumer staples stocks that aren’t selling inferior products like those in KXI are at risk. A 6% YTD decline doesn’t reflect fundamental realities. Even if the stock stays where it is, the cost will be lacking catalysts for any performance, and the money could end up lying dead.

Updated Economic View

The markets have seen some interesting activity. Enterprise tech did well, consumer tech less so, reflecting continued corporate optimism while there is consumer fear. We think things could still get bad for corporates as the realities of lower consumption set in and would continue to take the recession risk seriously.

Regardless of whether corporate pessimism will feed back into further consumer pessimism, consumption declines should already be a concern for consumer staples investors and investors in KXI because of the effects of downtrading. While some large consumer staples companies feature discount brands, for the most part, they have spent their money cultivating stronger brands where there is some pricing power, but the risk of downtrading on those brands is higher as consumer wallets get crimped by inflation.

KXI Breakdown

Stocks like Procter & Gamble (PG) but also Philip Morris (PM), which belong to the KXI, all have downtrading risks. P&G sports a broad portfolio and a lot of it is premium brands like Fairy, Pampers, etc. that could get switched out for supermarket branded items if consumers decide to lockdown their wallets. In the case of PM, there are rolling tobacco brands that competitors own, which could take share. Moreover, the loss of Russian and Ukrainian markets means they have to leverage their pricing power and probably donate cheaper customers to discount competitors. All the same points go for British American Tobacco (BTI) which also has to compete with Imperial Brands (OTCQX:IMBBY), another major contender and purveyor of discount products like rolling tobacco, in the very profitable and important American market, where rate hikes have been the most aggressive so far. Nestle (OTCPK:NSRGY) has quite a few discount brands but also plenty of premium ones.

However, we must acknowledge that there are some solid exposures that put KXI in a better position than some other consumer staples ETFs. Costco (COST) should be recession resistant, as will Walmart (WMT). Together these account for 8% of the portfolio. Coca-Cola (KO) might also withstand recession, especially as the out-of-home channel recovers and with a pretty unbeatable brand equity.

Conclusions

However, besides some stronger points, there is the general issue that these successful consumer staples companies have a lot of reliance on premium product on supermarket shelves to maintain their margins. Moreover, they’ve not been immune to inflation. If they get caught between downtrading while inflation persists, many of these companies will have a problem. The ETF has only declined 6% YTD. Things could get a lot worse from here, and when there is a clear threat like downtrading but no response on the price, that could be a sign to withdraw, for example into inferior products, while you still can.

While we don’t often do macroeconomic opinions, we do occasionally on our marketplace service here on Seeking Alpha, The Value Lab. We focus on long-only value ideas, where we try to find international mispriced equities and target a portfolio yield of about 4%. We’ve done really well for ourselves over the last 5 years, but it took getting our hands dirty in international markets. If you are a value-investor, serious about protecting your wealth, us at the Value Lab might be of inspiration. Give our no-strings-attached free trial a try to see if it’s for you.