Brand Names Make Bad Bargains
The defensive consumer-staples sector has been one of the better spaces in the S&P 1500 Index over the past couple years, delivering total returns of 6% in 2015 (third-highest of the 10 sectors) and 17% in 2014 (fourth). The sector has returned 6% so far this year, seventh-best in the index. However, most consumer-staples stocks don't appear to justify their now elevated valuations, especially considering sluggish sales growth amid changing shopper attitudes.
Purchases of household products have historically grown at about the same pace as the overall economy. But rising health-care costs and demand for travel and leisure activities are taking a bigger share of shoppers' wallets. Shifting trends in consumer preferences have also led to lower consumption of carbonated beverages, razors, and prepackaged foods.
During the financial crisis, many shoppers abandoned their allegiance to household-product brands by switching to cheaper, private-label goods produced by retailers. For instance, the 25 largest food and beverage companies grew U.S. sales of consumer packaged goods at a compound annual rate of just 0.1% from 2011 to 2015, according to industry researcher Nielsen. Private labels delivered 2.6% annualized growth over that stretch. In order to prop up sales, many large companies have resorted to heavy promotional activity, an expensive tactic.
Despite subpar sales, consumer-staples companies are delivering decent profit growth. S&P 1500 consumer-staples companies averaged 4% higher earnings per share over the past 12 months, twice the gain of the average stock in the S&P 1500 index, as shown below. Analysts expects the sector to average 7% higher profits this year, versus the index average of 4% growth.
But unlike shoppers, few investors are getting much of a bargain from these companies. Over the past decade, the sector's average P/E ratio relative to current-year estimated earnings is 18.6, below the S&P 1500 index average of 19.2. However, the sector now averages a current-year P/E of 23.2, above the index average of 21.5 Put another way, the consumer-staples sector has traded at a 3% discount to the index over the past decade but now trades at an 8% premium. Consumer staples has enjoyed a steeper premium in just 9% of months in the past decade.
Among the best-known companies in the sector, few offer compelling values, as shown in the table below. We recommend just two stocks in this space, CVS Health ($86; CVS) and Kroger ($29; KR). Both stocks are rated Buy and Long-Term Buy. Although both stocks have lagged this year, they boast decent operating momentum. They also offer attractive valuations, a rare phenomenon in the sector.