Consumer Staples Stock Outlook - May 2017

Can the Consumer Staples Sector Retain Its Mojo?

Stocks in Consumer Staples have maintained their defensive stance during periods of economic crisis. Companies in the sector sell relatively low-priced products that consumers use in their daily lives, like food, beverages and products for personal hygiene or household cleanliness. The purchase of these basic supplies is generally stable, irrespective of the spending patterns or whether the economy is expanding or contracting. Thus, the sector has been a consistent performer over time.

Market Scenario

Currently, the economy is in good shape. Lower oil prices and declining unemployment along with a resurgent housing market suggest that the economy is on a recovery mode. Domestic economic progress and a boost in infrastructure spending under President Trump’s administration bode well for the sector.

Though consumer confidence declined in April, we expect consumers to remain confident regarding the economy in the near term. This is likely to translate into higher consumer spending. GDP growth is also expected to improve in 2017 from last year, owing to recent improvement in financial conditions.

This is also evident from the 6.4% year-to-date (through May 10, 2017) rally in the Consumer Staples Select Sector SPDR ETF (NYSE:XLP) (XLP). Year to date, shares of consumer staples sector were up 7.8%, compared with the S&P 500’s 7.3% gain.

In fact, the bullishness is also reflected in the major key U.S. indices, which have closed in positive territory on a year-to-date basis. The Dow Jones Industrial Average (DJI) climbed 5.9% to 20,926.57, while the S&P 500 rose 7.2% to close at 2,398.87.

These factors signal growth in the economy, which will likely boost consumer spending – a key driver for the staples sector. However, a few disruptive trends will probably persist, which might influence investment approaches. There will also remain uncertainties related to Trump’s policies and over the timing at which the Federal Reserve will raise short-term interest rates, which will keep investors on their toes.

Zacks Industry Rank

The broader Consumer Staples sector is currently placed at bottom 19% of the Zacks Classified sectors (13 out of 16). We rank all the 250-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, the outlook for industries in the top one-third of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle one-third, or industries with Zacks Industry Ranks between #89 and #176 is 'Neutral,' and the bottom one-third, or Zacks Industry Rank of #177 and higher is 'Negative.'

The Consumer Staples sector is further sub-divided into the following industries at the expanded level (260 industry groups): Agricultural Operation, Beverages – Alcohol, Beverages – Soft, Consumer Products – Staples, Cosmetics, Food – Miscellaneous, Food – Meat Products, Food – Dairy Products, Food – Confectionary, Publishing – Newspapers, Publishing – Periodicals, Publishing – Books, Funeral Services, Soaps & Cleaning Materials, Textile – Apparel and Tobacco.

A number of these are placed in the top one-third of the 250+ industry groups, with Food – Meat Products carrying a Zacks Industry Rank #12. It is followed by Soaps & Cleaning Materials, Consumer Products – Staples and Tobacco carrying a Zacks Industry Rank #23, #44 and #50, respectively. Funeral Services and Cosmetics also fall in this category, with respective Zacks Industry Ranks #65 and #69.

Quite a few fall in the middle one-third, with Beverages – Alcohol and Beverages – Soft, each holding a Zacks Industry Rank #93. It is followed by Food – Confectionary, Publishing – Books, Agricultural Operations, Publishing – Periodicals, each with a Zacks Industry Rank #108.

The remaining are in the bottom one-third of the group. While Publishing – Newspapers carries a Zacks Industry Rank #179, Food – Dairy Products and Food – Miscellaneous sub-sectors have a respective Zacks Industry Rank #192 and #219. Textile – Apparel, holding a Zacks Industry Rank #246, is also in the bottom one-third.

Looking at the position of these industries, one could say that the general outlook for the Consumer Staples space is mixed. Though the companies in the sector are poised to benefit from cost-cutting initiatives and lower energy input costs, increased competition is a major drag for margins.

Earnings Trends

As earnings season picks up pace, investors seem to be happy with the way the quarter has shaped up. The reported figures show a stark improvement from the preceding quarter. At present, sectors like finance, technology, industrials, basic materials and business services look promising. The pace of growth is likely to be maintained in the second quarter as well.

On summarizing the performance of the 412 S&P 500 members that have come out with their financial results as of May 5, we see that total earnings improved 14.2% on a year-over-year basis (73.3% of the companies beat EPS estimates) while total revenue increased 7.3% (67.7% beat top-line expectations), per our Earnings Trends report.

About 75.0% of the S&P 500 companies in the Consumer Staple sector have reported their results, wherein 66.7% beat earnings estimates, while only 29.2% surpassed revenue estimates. While earnings rose 4.8% year over year, revenues declined 0.1%. Consumer Staples stocks appear to be struggling in terms of revenue, probably due to a difficult sales environment. According to the report, the sector is expected to record top-line growth of 4.0% and earnings growth of 4.4% this season on a margin increase of 0.1%.

Some Consumer Staples stocks in the S&P 500 -- like McCormick & Company (NYSE:MKC), Inc. (MKC), Kimberly-Clark Company (KMB), General Mills (NYSE:GIS), Inc. (GIS) and The Procter & Gamble Company (NYSE:PG) (PG) -- recently reported their quarterly numbers, wherein earnings beat the Zacks Consensus Estimate and revenues missed. Church & Dwight Company, Inc. (CHD), carrying a Zacks Rank #3 (Hold), exceeded earnings and revenues in its recently reported quarter. You can see ethe complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

On the other hand, companies like The Kraft Heinz Company (KHC) and Tyson Foods (NYSE:TSN), Inc. (TSN) lagged their earnings and revenue estimates.

Bottom Line

Consumer behavior pertaining to spending patterns and taste preferences has changed significantly over the years. This usually alters the earnings numbers for some large packaged-food manufacturers. Companies that respond promptly to the changing choices are expected to retain their advantage in 2017.

Also, the economy seems to be growing on the back of higher income and solid employment. The sector is also expected to grow on rising consumer spending.

However, an improvement in the economy will encourage investors to venture out of the defensive Consumer Staples, as the sector is viewed as a safe haven during periods of market volatility or economic downturns. Nevertheless, for the time being, the sector can safeguard risk-averse investors against an economy which is not free from global headwinds yet.

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