Consumer behavior and the service economy

Higher input prices are having an adverse impact on household sentiment. European sentiment indicator turned negative in March, while UK consumer confidence fell close to an all-time low in April. Surprisingly, U.S. consumer sentiment unexpectedly rose to a three-month high in early April. Although consumers have accumulated savings through the pandemic, we believe that consumers may prioritize leisure spending over discretionary goods in the months ahead.[1]

Not all product categories performed equally in this context of high inflation. Companies that emerged as winners during the height of the pandemic have fallen back since. The streaming giant Netflix reported a loss of 200,000 members in the first quarter, with a forecasted drop of 2 million this quarter. The company blames the password-sharing business for the loss in subscribers. Netflix, which is already the most expensive streaming platform, has recently increased its pricing in some Latin American countries for sharing accounts between households.[2] With an increased offering of streaming platforms at the same time as consumers are shifting their dollar spending elsewhere, it will be interesting to see how loyal subscribers are.

There are still areas in the economy where demand for goods remains robust. Companies associated with recreational and outdoor activities seem to report strong trading updates. Companies like POOLCORP, Tractor Supply Co and Gardena have benefited during their latest publications compared to last year.[3],[4] In general, we feel like the big ticket items could experience a growing trend going forward. On the other hand, food, health, and some services linked to the post-pandemic reopening might still experience robust growth.

There are some interesting data points that suggest strong spending patterns in service-related categories:

• OpenTable data suggests that consumer demand for restaurants continued its upward trajectory as of April 19, 2022. The Dining Out index, which tracks restaurant reservation data for approximately 20,000 restaurants across seven countries, shows that so far in 2022, the number of seated diners increased by 24% in the UK, 17% in the U.S. and 45% in Germany. Historically, higher gas prices have negatively impacted restaurant consumption as consumers change their eating habits, but this time around, consumers seems to be holding on to that spending category.

• Airlines and hotels have also seen an important surge in demand. Delta Air Lines returned to profitability during March, thanks to a passenger revenue that is back to 75% of pre-Covid levels. According to a survey conducted by the World Travel & Tourism Council, travellers are currently planning on spending more on travel leisure than they have in the past five years. [5],[6]

As the economy and consumer behaviours turn more towards services over goods, the exposure to small caps could provide investors with some upside.[7] Small caps, which tend to be more domestic, seem to have a stronger representation of services as opposed to goods. According to the Bank of America, the S&P 500 index derives around half of its earnings from spending on goods, whereas the Russell 2000 index generates only a quarter of its earnings from spending on goods.

Small-cap indices have a better representation of leisure services when comparing it with the S&P500. The weight in the leisure industry services is approximately 1% for the S&P 500 index, as opposed to 3% for the Russell 2000 index.

Some companies we own should benefit from that spending pattern:

Autogrill is the global leader by revenue in the F&B concessions market in airports, motorways, and railway stations. Autogrill and its subsidiary, HMSHost, manage a portfolio of about 300 owned and licensed brands in over 30 countries, including proprietary brands (Spizzico, Puro Gusto, etc.) and third-party franchises with a particular emphasis on global brands (Burger King, Starbucks, etc.).

Meliá is one of the leading European hotel groups; it owns and manages more than 326 hotels and resorts in 33 countries, mainly in America and Europe. Now that the majority of travel restrictions have been lifted, Meliá is seeing an uptick in demand for its leisure hotels. The Easter holiday was strong, and booking trends for the upcoming summer look firm. Although wider concerns around consumer softness are unlikely to completely fade at this stage, investors are likely to focus on mix shifts and changes in demand across product categories. Companies that have continued to invest and managed to enlarge their market positioning should be in a better position to offset the broader market slowdown.

[1] https://www.reuters.com/world/uk/uk-consumer-morale-plunges-near-all-time-low-april-gfk-2022-04-21/

[2] https://www.google.com/amp/s/www.cnbc.com/amp/2022/04/19/netflix-nflx-earnings-q1-2022.html

[3] https://finance.yahoo.com/news/zacks-analyst-blog-highlights-j-113011500.html

[4] https://www.google.com/amp/s/www.marketscreener.com/amp/quote/stock/HUSQVARNA-AB-PUBL-6498674/news/Husqvarna-Group-INTERIM-REPORT-JANUARY-MARCH-2022-Strong-demand-but-sales-affected-by-supply-ch-40125061/

[5] https://www.hospitalitynet.org/news/4110148.html

[6] https://www.barrons.com/articles/-travel-booming-again-hotels-airlines-51649890847

[7] https://financialpost.com/pmn/business-pmn/two-speed-euro-zone-economy-as-services-shine-factories-struggle-pmi