How to Profit from Disruption: Part 2

Consumer tastes and lifestyles are forever evolving and shoppers increasingly want cheaper, better, and more sustainable products and services. In the second in our series on disruption we look at car ownership, plastic manufacturing and personal healthcare, which are all areas affected by changing shopping trends.

Plastic Packaging

Single-use plastics, from cotton buds to water bottles, are now public enemy number one for sustainably-minded consumers. But companies that manufacture plastics can’t switch their production processes overnight, and many shoppers are finding it hard to go completely plastic free. Food and drink companies, whether coffee chains or soft drink makers, are on the frontline of this push for change, but some are adapting faster than others.

Leaders

Coca-Cola (KO)

Morningstar Rating: 2 stars
1 Year Return: 19%
Share Price: $57
Morningstar Fair Value Estimate: $57

As one of the biggest plastic manufacturers in the world, Coca Cola might seem a contrarian choice as a leader in the field. But fund manager Schroders says it's a sector leader in the field of plastic recycling. The firmt has committed to making its bottles with 50% of its recycled content by 2030. Morningstar analysts think the company’s shares are trading at a premium but the 128-year-old business has a “wide moat”, or strong competitive advantage – veteran investor Warren Buffett is a famous fan of the carbonated drink.

Danone (BN)

Morningstar Rating: 3 stars
1 Year Return: 13%
Share Price: €69
Morningstar Fair Value Estimate: €71

French company Danone is ahead of Coca-Cola - it plans to make all Evian water bottles from recycled plastic by 2025. Danone also makes yoghurts and can tap into the shift away from dairy products toward soya and other alternatives; it owns one of the biggest European soya milk brands, Alpro, for example.

Danone, which is the third-largest packaged water company in the world, is rated as a three-star stock by Morningstar analysts, which means they believe shares are fairly valued.

Laggards

Starbucks (SBUX)

Morningstar Rating: 3 stars
1 Year Return: 24%
Share Price: $82
Morningstar Fair Value Estimate: $92

With the coffee boom of the past two decades, a lot of plastic coffee cup lids are now piling up in landfill. Many shops now incentivise customers to bring their own drinking vessels by offering small discounts, among them Starbucks. But the US firm has wobbled in its commitments to recyclable and resuable packaging, with only shareholder pressure bringing Starbucks back on track.

Nestle (NESN)

Morningstar Rating: 2 stars
1 Year Return: 25%
Share Price: SFr103
Morningstar Fair Value Estimate: SFr91

Behind Coca-Cola, Nestle is the second biggest maker of plastic bottles in the world with its stable of brands including Perrier, Vittel and San Pellegrino. Companies like Coca-Cola, Unilever and Nestle have signed up to the “New Plastics Economy Global Commitment”, a tie-up between the charity, the Ellen MacArthur Foundation and the United Nations. The first report from the initiative shows that Coca-Cola is the leader, using 9% of recycled content, but Nestle uses just 2% (Unilever is even further behind, using less than 1% of recycled content).

Personal Grooming

Worldwide, people spend billions on razors, make-up and other personal grooming products. In the pre-internet age, consumers had little alternative but to pay the prices charged by dominant players such as Gillette and L’Oreal. And while the brand power of these companies still means they retain significant market share, canny entrepreneurs have looked to disrupt this model by offering cheaper products and marketing them via social media.

Leaders

Dollar Shave Club (Unilever) (ULVR)

Morningstar Rating: 3 stars
1 Year Return 12%
Share Price: £43
Morningstar Fair Value Estimate: £47

Shaving clubs have spent heavily on marketing to break the stranglehold of Gillette and Wilkinson Sword. Razors-by-mail company Harry’s, for example, launched in 2012 and was the subject of a $1.4 billion bid in 2019. It claims to have more than 10 million subscribers worldwide. Dollar Shave Club is a similar model and launched via a YouTube video in 2012; it was bought for $1 billion by Unilever in 2016.

Warpaint London (W7L)

Morningstar Rating: n/a
1 Year Return: 1%
Share Price: 92
Morningstar Fair Value Estimate: n/a

UK-based Warpaint London was founded in 2002 with the aim of taking on the cosmetic giants L’Oreal and Estee Lauder; its pitch is to women (and men through its Man’s Stuff brand) aged between 16 and 30 through affordable products. Brands W7 and Technic are sold through UK supermarkets and it also provides “white-label” services to companies to sell under their own brands. The Aim-listed company is expecting profits of £5.2 million for 2019 on revenue of £49.3 million (2018 figures were £4.73 million of profit on £48.5 million of revenue).

Laggards

L’Oreal (OR)

Morningstar Rating: 2 stars
1 Year Return: 24%
Share Price: €248
Morningstar Fair Value Estimate: €193

It’s a bold call to rule out one of the biggest names in the cosmetic industry, but Morningstar analysts say the French company’s dominance is very much priced in. Granted, it has a wide economic moat, but barriers to entry are falling and smaller companies can leverage social media such as Instagram influencers to promote their products. Analyst Rebecca Scheuneman says: “We think investors fail to appreciate the highly competitive nature of the industry, with independent makeup brands taking advantage of lower barriers to entry provided by the increasing prevalence of e-commerce and digital marketing. Several of these brands are gaining traction in North America in particular.”

Gillette (Procter & Gamble) (PG)

Morningstar Rating: 2 stars
1 Year Return: 29%
Share Price: $121
Morningstar Fair Value Estimate: $109

Gillette may be “the best that man can get” but the inroads made by Harry’s and Dollar Shave Club suggest there is an appetite for cheaper shaving products. Gillette still has more than 50% market share, a stonking advantage in any consumer industry, but wider trends are eating into profit margins: beards are (for now) fashionable, and savvy shoppers are looking online for cheaper Gillette products or unbranded shaving products. Consumer marketing research firm Mintel estimates that the total value of shaving products declined globally in 2018 even as the male grooming industry expanded (think more moisturiser, fewer razors).

Cars

Owning a car is an expensive business; in the UK there’s a long list of costs just to keep a vehicle on the road. But there’s also climate change to consider. Car clubs and ride-sharing have sprung up as cheaper alternatives to having a shiny new vehicle on the drive and that’s bad news for car manufacturers, whose business model depends on people ugrading their car every year or so, and it’s terrible news for used car salesmen.

Leaders

Uber (UBER)

Morningstar Rating: 4 stars
1 Year Return: -2%
Share Price: $35
Morningstar Fair Value Estimate: $58

When people talk about disruption, Uber is one of the first names to come to mind: “Uber it” has entered the lexicon in much the same way as “Google it”. Uber has had many problems since launch; it lost its license in London in 2019, its IPO has so far disappointed, and now Indian rival Ola is about to launch in the UK. Still, Morningstar analysts think Uber has first-mover advantage in a rapidly growing global market and places a fair value estimate of $58, $20 above its current price.

Zipcar (Avis Budget) (CAR)

Morningstar Rating: n/a
1 Year Return: 30%
Share Price: $40
Morningstar Fair Value Estimate: n/a

Zipcar was one of the first car clubs to launch in London and in many UK cities you can hire a car for less than £10 an hour. Uber’s license troubles in London suggest that car clubs face less regulatory scrutiny than taxi firms. Traditional companies have not been slow to see the opportunities for start-ups in this area, however, and Zipcar was bought by rental car company Avis Budget in 2013.

Laggards

Morningstar Rating: n/a
1 Year Return: -52%
Share Price: 12p
Morningstar Fair Value Estimate: n/a

Pendragon (PDG)

It’s been a tough period for the UK car industry: the number of cars produced in 2019 fell by nearly 15% to the lowest level in 10 years. Consumers are deserting diesel vehicles but electric vehicles are not yet filling the void. Meanwhile, Brexit has dented consumer confidence, making people less likely to take out expensive cars on hire purchase agreements. And the Government has just announced that petrol and diesel cars will no longer be sold from 2035 – five years ahead of its previous schedule. Used and new car sales firm Pendragon is in the eye of this perfect storm, and its shares have halved in a year.

Peugeot SA (UG)

Morningstar Rating: 3 stars
1 Year Return: -10%
Share Price: €17
Morningstar Fair Value Estimate: €17

Any European car manufacturer – perhaps excluding Morningstar analysts' favourite BMW – could fit in this list of laggards. Many, such as Volkswagen, have been pioneers in electric vehicle development but the fundamental problem is that there are too many cars being made in Europe and not enough buyers. Will the UK driver want to buy European cars now the country has left the EU and once-tariff-free Golfs and Audis become more expensive? Morningstar’s Richard Hilgert puts Peugeot's woes in context: “The company suffers from a high-cost manufacturing footprint, overcapacity, heavy reliance on French and German demand, and a socialist government agenda that favours organised labour and prohibits rationalisation.”