Adam Ismail10.01.11
This column typically touches on the macroeconomic themes, mergers and acquisitions (M&A), stock market valuations and IPOs affecting the nutrition industry. If you read the financial press right now, it sure seems like there is something bad brewing, so it is probably a good time to discuss how all of these areas might be affected if the economy swiftly goes south.
The Unemployment Rate
The good news—if there is any—is that the nutrition industry has demonstrated multiple times that it can withstand recessions. Yes, growth slows down, but at the end of the day the industry still grows. The unemployment problem is serious in the U.S., though, and it has mostly affected low-income households. Consumer data show that the typical supplement consumer is generally from a middle- to upper-income household, which may help explain the industry’s resilience. Putting aside the social commentary about how lower-income households need better nutrition than most, one danger sign for the industry to watch going forward is the unemployment rate in the middle class.
The theory espoused most often about why the industry fared well in 2008 is that consumers started to seek out supplements to help them stay healthy at a time when they were financially vulnerable. When the middle class starts to show economic weakness, this whole theory may collapse. To watch this, go to the Federal Reserve Economics Database (FRED) (http://research.stlouisfed.org/fred2/graph/?g=2aq).
Credit Supply
The next knock-on effect of a recession is that credit supply will shrink, making it difficult for companies to get the financing they need to operate their businesses. However, most raw materials used in nutraceuticals do not require significant financing, as opposed to other industries, because purchases are spaced out over the course of a year and costs are relatively small compared to the final sales price.
There are some notable exceptions like fish oils where inventories are built up during open fishing seasons, but for the most part, a credit crunch should not have a big impact on the nutraceuticals industry. Again, in 2008 the lack of credit worried many nutrition companies, but its impact on overall industry growth was minimal.
Still, it is likely that tighter credit will have a more significant impact on the M&A side of the business. There have been several large deals in this space during the past year, and debt has played a key role in many of them, especially the Carlyle-NBTY acquisition. In particular, if credit is not readily available and/or interest rates rise, then we may see fewer and fewer private equity companies buying nutrition companies. This does not mean that the M&A market will be dead, but we might only see deals of significant size from companies with ample cash on their balance sheets that want to take advantage of an illiquid market. In general, these will be the larger companies like DSM, BASF, etc., which have the cash and have already shown an interest in being acquisitive. Again, the FRED database is an excellent place to turn to keep an eye on business credit trends (http://research.stlouisfed.org/fred2/series/EVANQ?cid=32362).
The Public Markets
The next areas to look at are the public markets. It is harder and harder to analyze public equities in the nutrition space because the larger companies either get acquired or take themselves private. However, fear makes stocks more volatile, so one indicator that gives some useful insights on how the market views nutrition prospects is the “Beta” of individual stocks because it compares the volatility of the stock to the general market volatility.
Beta values of 1 mean the stock market has treated it as equally volatile to the overall market, whereas Betas of 2 mean the stock has been twice as volatile. Most of the public companies in this space have volatilities at or below 1.0, meaning they have been less volatile than the rest of the market. So the market is actually viewing the nutrition space as more stable than the rest of the market. The only exceptions seem to be the companies that have heavy sales outside the U.S. like the network marketers, which is interesting because geographic diversification does not appear to the market to be a risk mitigation strategy. Regardless, keeping an eye on these Betas will reveal any emerging shift in market sentiment toward nutrition companies.
The IPO Market
Lastly, the IPO market could also be affected, in large part because it tends to act like its own independent market. For example, if a nutraceutical company like NBTY wanted to go public again, its ability to do so might have nothing to do with its sector or the strength of its supplement business. If other sectors are having trouble placing IPOs, then it is likely to affect a supplement company too because banks do not want to take the risk of selling the shares.
In fact, it is very telling that there have been just a couple IPOs in the nutrition industry since the 2008 financial crisis. Even though the IPO market has started to rebound, many market participants still see risk and IPOs in other industries are starting to fail.
The Unemployment Rate
The good news—if there is any—is that the nutrition industry has demonstrated multiple times that it can withstand recessions. Yes, growth slows down, but at the end of the day the industry still grows. The unemployment problem is serious in the U.S., though, and it has mostly affected low-income households. Consumer data show that the typical supplement consumer is generally from a middle- to upper-income household, which may help explain the industry’s resilience. Putting aside the social commentary about how lower-income households need better nutrition than most, one danger sign for the industry to watch going forward is the unemployment rate in the middle class.
The theory espoused most often about why the industry fared well in 2008 is that consumers started to seek out supplements to help them stay healthy at a time when they were financially vulnerable. When the middle class starts to show economic weakness, this whole theory may collapse. To watch this, go to the Federal Reserve Economics Database (FRED) (http://research.stlouisfed.org/fred2/graph/?g=2aq).
Credit Supply
The next knock-on effect of a recession is that credit supply will shrink, making it difficult for companies to get the financing they need to operate their businesses. However, most raw materials used in nutraceuticals do not require significant financing, as opposed to other industries, because purchases are spaced out over the course of a year and costs are relatively small compared to the final sales price.
There are some notable exceptions like fish oils where inventories are built up during open fishing seasons, but for the most part, a credit crunch should not have a big impact on the nutraceuticals industry. Again, in 2008 the lack of credit worried many nutrition companies, but its impact on overall industry growth was minimal.
Still, it is likely that tighter credit will have a more significant impact on the M&A side of the business. There have been several large deals in this space during the past year, and debt has played a key role in many of them, especially the Carlyle-NBTY acquisition. In particular, if credit is not readily available and/or interest rates rise, then we may see fewer and fewer private equity companies buying nutrition companies. This does not mean that the M&A market will be dead, but we might only see deals of significant size from companies with ample cash on their balance sheets that want to take advantage of an illiquid market. In general, these will be the larger companies like DSM, BASF, etc., which have the cash and have already shown an interest in being acquisitive. Again, the FRED database is an excellent place to turn to keep an eye on business credit trends (http://research.stlouisfed.org/fred2/series/EVANQ?cid=32362).
The Public Markets
The next areas to look at are the public markets. It is harder and harder to analyze public equities in the nutrition space because the larger companies either get acquired or take themselves private. However, fear makes stocks more volatile, so one indicator that gives some useful insights on how the market views nutrition prospects is the “Beta” of individual stocks because it compares the volatility of the stock to the general market volatility.
Beta values of 1 mean the stock market has treated it as equally volatile to the overall market, whereas Betas of 2 mean the stock has been twice as volatile. Most of the public companies in this space have volatilities at or below 1.0, meaning they have been less volatile than the rest of the market. So the market is actually viewing the nutrition space as more stable than the rest of the market. The only exceptions seem to be the companies that have heavy sales outside the U.S. like the network marketers, which is interesting because geographic diversification does not appear to the market to be a risk mitigation strategy. Regardless, keeping an eye on these Betas will reveal any emerging shift in market sentiment toward nutrition companies.
The IPO Market
Lastly, the IPO market could also be affected, in large part because it tends to act like its own independent market. For example, if a nutraceutical company like NBTY wanted to go public again, its ability to do so might have nothing to do with its sector or the strength of its supplement business. If other sectors are having trouble placing IPOs, then it is likely to affect a supplement company too because banks do not want to take the risk of selling the shares.
In fact, it is very telling that there have been just a couple IPOs in the nutrition industry since the 2008 financial crisis. Even though the IPO market has started to rebound, many market participants still see risk and IPOs in other industries are starting to fail.
