For long-term investors, the allure of businesses possessing a loyal and repeat customer base, pricing power and scale, a differentiated product offering and staying power is difficult to overstate. At QV, the search for these quality attributes within a business often leads our team members to gravitate toward companies with strong, recognizable consumer brands. Although brands are intangible and often difficult to value, their benefits are real and measurable, and can often result in meaningful value creation. A business underpinned by established consumer brands will often exhibit many desirable qualities:
Enhanced recognition and customer loyalty
Established brands are often supported by steady investments (advertising & promotion, R&D, slogans, logos) which invariably produce high levels of brand awareness. Brand recognition in combination with its value proposition (differentiation, quality, customer experience) work together to create customer loyalty, which is powerful when we think about brand equity or the intrinsic value of a business. Many businesses with strong consumer brands will generate more predictable revenues and cashflow streams – in good times and in bad.
Competitive Advantages: pricing power, scale and higher profitability
A by-product of customer loyalty is often a willingness to pay a premium price relative to a competitor’s offering. Scale benefits are also noteworthy as leading brands often yield comparatively lower promotional, advertising, R&D and distribution costs as these value creating investments are spread out across a more extensive revenue base. This can produce market share gains as well as lower customer acquisition costs and product development costs relative to competitors. Lastly, the combination of pricing power and scale will usually drive stronger financial performance – notably higher profit margins and stronger returns on invested capital.
Diversification, durability and value considerations
Diversification across product categories and geographies can enhance the overall stability of a business, while also providing some of the scale benefits outlined above. Leading brands also possess enduring qualities – having withstood the test of time, prospering through economic cycles while also adapting to changing consumer preferences and defending against the threat of new entrants. From a value perspective, investors should note that the intrinsic value of most market-leading brands far exceeds their carrying value on a company’s balance sheet. Current accounting rules dictate that internally generated intangible assets such as brands cannot be capitalized. As such, many of the ‘brand building’ investments noted above are required to flow through the income statement – resulting in an understatement of underlying value and distortion of valuation ratios.
LEADING CONSUMER BRANDS WITHIN QV PORTFOLIOS
Shares of Unilever (UL) were added to QV’s Global Equity Strategy earlier this year. As a leading global consumer goods franchise, UL exemplifies the benefits of steady and predictable growth characteristics underpinned by a diversified portfolio of market leading consumer brands. Most readers would recognize several UL brands in the grocery store, including Axe, Dove, Vaseline, Ben & Jerry’s, Hellman’s and Lipton’s. In fact, the company owns 13 $1 billion+ brands within its broader portfolio of several hundred brands. With annual revenues in excess of US $60 billion, UL possesses the size and scale to re-invest and innovate across its portfolio to ensure that its brands retain their value proposition and remain relevant with consumers. UL’s management team has steadily increased underlying operating margins since 2016 while the company’s relatively high return on equity of nearly 40% is additive to portfolio quality. UL shares trade at a discounted valuation relative to its peers and offer attractive expected returns at current levels.
Shares of Alphabet are also held across QV client portfolios. The Google brand (Alphabet’s main asset) has become synonymous with online search and commands a dominant share (if not monopoly-like share) of this market. Google’s main business, online advertising, has been the primary beneficiary of advertising dollars shifting into the digital realm. Google, through products such as Chrome, Android, and its Google apps, effectively imbeds users into its ecosystem and provides advertisers with targeted ad spending opportunities, yielding a much improved return on investment for every advertising dollar expended. The dominance of the Google brand in digital advertising has enabled it to leverage its brand reach into ancillary businesses such as YouTube and non ad businesses such as Cloud and Play. As a result, Alphabet’s fundamentals are among the best of any business held in our portfolios – with an ability to compound value at above-average rates and a capacity to re-invest in its business on a scale that is unparalleled among its competitors. We believe that this will serve to only strengthen its dominant competitive position and lead to further intrinsic value growth over time.