Expect rising tensions as consumer companies aim to maintain strong growth from pandemic-related tailwinds in 2020 in the face of cost pressures.

Many companies across the investment grade consumer and retail universe enjoyed tailwinds from increased consumer demand due to behavior and shopping changes during COVID-19. Having spent 2020 navigating the uncertain and quickly changing environment, COVID “beneficiaries” are now focused on sustaining this growth momentum in 2021. Internally, companies are turning to increased capex and investment to improve technology and enhance digital capabilities to support growth. However, externally, the environment remains highly competitive, with inflationary forces across commodities, transportation and labor, creating headwinds.

For manufacturers, a natural response to rising input costs will be to raise prices. While many consumer companies intend to try this tactic in a targeted, category-by-category way, we expect the balance of power to tilt toward retailers. Let’s take Walmart, for example, a top customer for many of the consumer manufacturers. At its recent investors’ day, Walmart reiterated its goal to maintain price leadership in a thoughtful and strategic way, expressing satisfaction with current price gaps—suggesting that willingness to agree to list-price increases may be low. Facing its own inflationary pressures from wages, Walmart remains focused on driving volumes in its core while diversifying its profit base and appears unlikely to engage in strategies that would cause it to deviate from its customer-centric business model.

Over the course of the year, we believe that rising tensions between these sectors will force consumer companies to look inward for levers to offset cost inflation. The toolkit could feature cost savings and productivity programs, product-mix enhancements, price-pack architecture, innovation and premiumization. These strategies will likely require increased investments in technology, supply chains and digital capabilities, which many companies are planning over the course of 2021.

While increased investments in innovation should drive organic-growth agendas, we also expect companies to turn to inorganic growth opportunities. Despite high valuations, management teams anecdotally are describing an increasingly hot M&A environment. Specifically, we expect increased bolt-on M&A activity as consumer companies scrutinize current portfolios, and sell lower-growth, nonstrategic brands that fit better in the portfolio of a sector peer or strategic owner. The market is underappreciating some of these rising risks in the packaged food and consumer product sectors, but we continue to find value in select beverage and retail credits. As COVID-19 tailwinds abate, leaders and laggards will emerge over the course of 2021, as competing agendas arise in the race to sustain growth.