Adam Ismail03.01.08
Global Affairs Hit Home
Global economic problems have begun to panic and stress consumer populations around the world.
ByAdam Ismail
Issues like the subprime mortgage crisis, inflation fears, and interest rate reductions may seem far and distant from the nutrition industry, but they have the potential to dramatically affect several areas in the industry. This industry continues to enjoy high growth rates relative to other industries, so there may be a bias to not worry about how these issues touch nutraceuticals, but this could be a dangerous tack to take.
The Impact of Subprime Mortgages
The subprime mortgage crisis has the potential to affect the space in two ways. First, much has been written about how the U.S. economy has grown on the backs of American consumers borrowing against the values of their homes. It seems like it would be hard to draw the conclusion that the nutraceuticals industry has grown because people have been taking out second mortgages to buy things like dietary supplements and functional foods. However, nobody has done enough research to know what will happen when consumers begin cutting back their spending because they do not have the same available cash that they used to have.
During the last recession, industry growth slowed from double-digit growth to around 6-7% annual growth. What is interesting about that recession is it was primarily driven by the destruction of wealth associated with the Internet bubble bursting. The subprime mortgage crisis and the overzealous homebuilding sector have flooded the market with homes that are not being bought. As a result, home prices are falling, resulting in a very similar destruction of wealth! Yet, how many companies in this space recognize this and are planning for slowing consumer spending on nutraceuticals?
The second impact of the subprime crisis is that banks are increasingly less willing to loan money to companies, and even in the cases where they are, it is at higher rates to compensate themselves for what they perceive as higher risk. While the impact may slightly increase the interest charges for nutraceutical companies, the bigger impact will be on company valuations. In the public markets, Table 1 shows how far some of the leading stocks in this industry have fallen since last September, before the extent of the crisis was known. By comparison, the S&P 500 has only fallen about 13% in the same period. The stocks that seem to have performed the best were the ones that were most diversified outside of the U.S., like network marketers.
If the public markets are any indication, this may also lead to a slowdown of acquisition activity in the space, or at least for the higher quality companies, as lower valuations make companies less inclined to sell. There may also be a wave of new companies for sale that could benefit from a more financially secure owner. In the acquisition market it may still be another three to six months before these effects are fully visible, but if recession comes it will be very pronounced.
Inflation & Interest Rates
It is worth noting here that while the Federal Reserve has been cutting rates rather aggressively to stave off or minimize the effects of a recession, it has not materialized as a reduction in borrowing rates for corporations. This may not seem logical because the Fed rate is seen as a benchmark rate, but ultimately rates are set by supply of available funds and demand for loans. The impact of the subprime crisis is that the supply of available funds has shrunk dramatically, and companies are tightening their spending and overall may need to borrow less.
The one effect lower interest rates can have on this space, however, is that they can help stave off inflation. While consumer spending on foods and beverages is not overly sensitive to gradual price increases, spending on premium-priced products like some functional foods or dietary supplements may be more sensitive. One of the early warning indicators will be to watch how sales of the higher priced products are affected in categories where there is a wide disparity in pricing between products, like CoQ10 supplements or yogurts and fermented milk drinks.
Certain categories may be immune to the negative effects of inflation, such as glucosamine and chondroitin products because these products are used to manage pain in consumers’ daily lives. One thing is certain, however, preventive products that are seen as discretionary will be most at risk.
Conclusion
How each company adapts to an economic downturn really depends on the specifics of each company, like how much it depends on new product launches, what its competitive situation is, where it expects new growth to come from, etc. Regardless of the situation, though, every company should be doing some scenario planning on the potential effects of an economic downturn and be ready to react.NW