Two important records were broken in 2019. At one point, the value of negative-yielding bonds reached almost $17 trillion. And during the course of the year, over 9,300 U.S. retail stores were shuttered—compared with fewer than 7,000 during the 2008 financial crisis and around 2,500 in a typical year.
At this point, you might mistake us for our colleagues in real estate, making the case for a high-yielding asset class that thrives in the late cycle, and which is positioned to benefit from the counterintuitive bricks-and-mortar demand that arises from the “Amazonification” of retail.
In fact, we’d like to flag what we see as a once-in-a-lifetime opportunity in a very different income-generating asset class: the royalty streams from consumer brands and trademarks.
Investors can buy brands from their current owners and license them to others, often manufacturers and wholesalers.
For example, one could buy a kidswear brand that is well known in one geographical market and license it as a chain store exclusive in another market; or perhaps take a clothing brand and license it for another sector, such as luggage or sunglasses. The licensee pays a royalty, which is generally 7 – 12% of wholesale sales associated with the brand.
That is the income and yield argument: this asset class is very cash-generative.
It also has some downside mitigation and upside potential. Downside mitigation comes from the Guaranteed Minimum Royalty (GMR) that most licensing contracts require, regardless of the sales that licensees achieve with the brand. Upside potential comes from working to enhance the value of the brand and licensing it, diligently, in new markets, channels and categories. Unlike drug patents or depleting natural resources, trademarks typically don’t expire, so licensed brands can generate cash for years unless they fall out of favor with the consumer.
Aren’t these attractive assets prohibitively expensive? Not necessarily.
The manufacturers who tend to develop brands care about them, but their main business is making and selling goods. By contrast, an investor can focus entirely on the reach and visibility of the brands they acquire from these manufacturers. That is why investors who work to enhance these brands can acquire them at attractive multiples, currently by our estimate around 7 – 10 times EBITDA, or a 6 – 8% yield. Some diversified portfolios of brands have traded for EBITDA multiples in the mid-teens.
Retail in Transition
But how can we make a case for consumer brands when Main Street retail is having such a tough time?
Like our real estate colleagues, we would point out that retail is not disappearing, but changing.
U.S. retail sales grew by more than 3% in 2019 and have grown more than 4% per year, on average, since 2010, according to U.S. Census Bureau figures. That growth has moved to global ecommerce, but we also see growth on Main Street for concession stores and “off-price” retailers, all of which create more and more mass-market demand for quality brands.
This is what we mean by a once-in-a-lifetime opportunity. The potential to grow a brand’s reach and visibility is unprecedented in the new retail environment, but many of the owners of those brands are struggling with the transition—rationalizing their store footprint or even staving off bankruptcy. We have never seen as much opportunity to acquire very strong, heritage brands trapped inside challenged operating companies.
For investors, that can mean a highly unusual combination of value, income and growth potential in those brands.
Moreover, brand value and brand royalty income are relatively low-volatility (partly due to the GMR) and exhibit little correlation with traditional credit or equity markets. Sales ebb and flow with the cycle, but investors are able to buy decades-old, quality mid- and mass-market brands that have stood the test of time. The nature of the asset class also makes diversifying a portfolio by product, sector, channel and geography relatively easy.
As this cycle ages—with high equity valuations, low bond yields and a short supply of growth—we think consumer brands are a potentially useful and underappreciated addition to a portfolio. As the retail landscape continues to change, we believe they can prove their worth as a strategic allocation, too.
In Case You Missed It
- U.S. Consumer Price Index: +0.2% in December month-over-month and +2.3% year-over-year (core CPI increased 0.1% month-over-month and 2.3% year-over-year)
- U.S. Producer Price Index: +0.1% in December month-over-month and +1.3% year-over-year
- U.S. Retail Sales: +0.3% in December
- NAHB Housing Market Index: -1.0 to 75 in January
- China 4Q 2019 GDP: +6.0% annualized rate
- U.S. Housing Starts: +16.9% to SAAR of 1.61 million units in December
- U.S. Building Permits: -3.9% to SAAR of 1.42 million units in December
What to Watch For
- Tuesday, January 21:
- Bank of Japan Policy Rate Decision
- Wednesday, January 22:
- U.S. Existing Home Sales
- Thursday, January 23:
- European Central Bank Policy Meeting
- Japan Purchasing Managers’ Index
- Japan Consumer Price Index
- Friday, January 24:
- Euro Zone Purchasing Managers’ Index
Statistics on the Current State of the Market – as of January 17, 2020
|S&P 500 Index||2.0%||3.1%||3.1%|
|Russell 1000 Index||2.0%||3.2%||3.2%|
|Russell 1000 Growth Index||2.3%||4.9%||4.9%|
|Russell 1000 Value Index||1.7%||1.4%||1.4%|
|Russell 2000 Index||2.5%||1.9%||1.9%|
|MSCI World Index||1.6%||2.5%||2.5%|
|MSCI EAFE Index||0.9%||1.0%||1.0%|
|MSCI Emerging Markets Index||1.2%||2.9%||2.9%|
|STOXX Europe 600||1.1%||1.0%||1.0%|
|FTSE 100 Index||1.2%||1.8%||1.8%|
|CSI 300 Index||-0.2%||1.4%||1.4%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.1%||0.1%|
|Citigroup 10-Year Treasury Index||0.0%||0.8%||0.8%|
|Bloomberg Barclays Municipal Bond Index||0.3%||1.0%||1.0%|
|Bloomberg Barclays US Aggregate Bond Index||0.1%||0.5%||0.5%|
|Bloomberg Barclays Global Aggregate Index||0.0%||-0.2%||-0.2%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.1%||0.6%||0.6%|
|ICE BofAML U.S. High Yield Index||0.3%||0.8%||0.8%|
|ICE BofAML Global High Yield Index||0.3%||0.7%||0.7%|
|JP Morgan EMBI Global Diversified Index||0.4%||0.9%||0.9%|
|JP Morgan GBI-EM Global Diversified Index||-0.4%||-0.2%||-0.2%|
|U.S. Dollar per British Pounds||-0.2%||-1.6%||-1.6%|
|U.S. Dollar per Euro||-0.2%||-1.2%||-1.2%|
|U.S. Dollar per Japanese Yen||-0.6%||-1.4%||-1.4%|
|Real & Alternative Assets|
|Alerian MLP Index||1.4%||3.8%||3.8%|
|FTSE EPRA/NAREIT North America Index||2.9%||2.2%||2.2%|
|FTSE EPRA/NAREIT Global Index||2.3%||1.6%||1.6%|
|Bloomberg Commodity Index||-1.1%||-1.3%||-1.3%|
|Gold (NYM $/ozt) Continuous Future||0.0%||2.4%||2.4%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||-0.8%||-4.1%||-4.1%|
Source: FactSet, Neuberger Berman.