Consumer spending is going through a 'normalization': Analyst

Amid questions around slowing consumer spending, RBC's Capital Markets Managing Director Nik Modi says consumers are not entirely cutting back on spending, but instead exhibiting caution. Shoppers still buy desired goods, just in notably smaller quantities or sizes.

Modi notes beauty categories and fragrances typically see seasonal demand boosts, but he has seen some "marginal" trade downs and says that if foot traffic comes under pressure, if could impact the sector. Rather than elimination, Modi sees ongoing "normalization" in discretionary consumer spend. Consumers remain interested in indulgent purchases, though perhaps at more measured levels aligned with cooling factors like inflation.

"They still want that candy bar, but they're buying a smaller size. They still want that beverage/alcohol product or spirits, but they're going to 750 mL versus the one and a half liters," Modi tells Yahoo Finance, adding: "...in some instances we're just seeing consumers make choices."

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Video Transcript

RACHELLE AKUFFO: I want to first start with non-discretionary, the needs that consumers have right now. What are you seeing in terms of how they're spending their and what they're trading down and some of perhaps the leaders in this space?

NIK MODI: Yeah, it's an interesting thing. I mean, we've been kind of flagging a deteriorating consumer backdrop since actually late last year because we were seeing a lot of movement and evidence within the marketplace, at least with the companies that we've been covering. So it's not like consumers are cutting back entirely on consumer goods or consumer staples consumption. What they're doing-- and I think Walmart's phrase of choiceful is very appropriate. They are being very choiceful.

They still want that candy bar, but they're buying a smaller size. They still want that beverage alcohol product or spirits, but they're going to 750 milliliters versus the 1 and 1/2 liter. So we're seeing a lot of pack size downgrade.

We are seeing private label shares pick up in many categories across the consumer goods space. And in some instances, we're seeing consumers just make choices. I mean we did a report recently where there are consumers that are literally skipping meals and so you're seeing that impact the packaged food space.

AKIKO FUJITA: And that raises the question, Nik, as we go into the holiday season, what this means for some of the other retailers smaller compared to Walmart? . If Walmart and Target are talking about more discounting going into December, what are some other names that you'll be watching for to get a real pulse on just how far, the consumer is willing to go in this environment?

NIK MODI: Yeah, so one thing that we like to look at, especially during the holiday season, is the beauty companies, right? Obviously, beauty, fragrance in particular, is a very popular gift item during the holiday season. But it tends to be on much more of the defensive end of what you would call discretionary consumption, right? So it tends to get impacted less than, let's say, a cashmere sweater, for instance.

So we'll be looking for evidence of what's going on in that category. What we're finding right now in beauty is the categories are actually pretty healthy, but we're seeing some marginal trade down across price tiers. So we're going to watch that. My suspicion is if foot traffic, it comes under pressure, that will affect the beauty category because a lot of that is also impulse consumption when you're in the store.

So from my coverage, that's probably the discretionary end of the stocks that I look at. One of the other companies I cover, Spectrum Brands, they announced this morning and they sell a lot of kitchen appliances. And that continues to be weak, so we're expecting that to be an ongoing area of sluggishness across a lot of the companies we look at.

RACHELLE AKUFFO: And we also noticed you mentioned that and also big ticket items. We saw from the likes of Home Depot, seeing people pulling back on things like, you know, some of these big home improvements, instead of making, sort of, slight changes there. Is that something that's expected to continue?

NIK MODI: Based on all the work we've done with retailers, it looks like that will continue. And you know, what we're trying to do is get visibility on what the curve will look like in 2024. That's the work we're doing right now.

So is this going to be much more of a first half dynamic where the consumer is, kind of, under pressure? But then when we start lapping some of the weakness we saw this year, we'll start seeing some improvements in the back half of next year. So what we're doing work on right now is trying to understand what the shape of 2024 will look like.

If you really think about what's happening, right, outside of maybe some potential dynamics in the real-estate market, what could effectively be happening right now is just the normalization of spend. So when you look at it versus 2019, things still look OK. But when you look at it versus last year where things were really hot and heavy when it came to spending, you're seeing year-over-year drags. And so when we get into next year, will we see some of that subside? And so that's really what we're focused on right now.