C.J. Lawrence Weekly – Sector Watch: Consumer Staples’ Premium Valuation at Risk
The Consumer Staples sector has historically been viewed as a safe port in a market storm and a key component sector to diversified portfolios. The thesis has held that the consistency of sales and relatively high dividend yields of sector constituents are the defensive characteristics sought by investors in “risk-off” environments. After all, consumers don’t stop brushing their teeth or drinking beer during crisis, as the saying goes. In 1990 the S&P Consumer Staples carried the highest weighting among all sectors in the S&P 500 at 14.1%. The onset of Operation Desert Storm, and an ensuing recession, likely contributed to the sector inflows during that period. Today, the Staples sector weighting within the index stands at 8.1%, the lowest level since the 1970s.
The Staples sector consists of six sub-indices including, in descending market weight order; Beverages, Food and Staples Retailing, Household Products, Tobacco, Food Products, and Personal Care. Only the Food Products group is down year-to-date (-5.1%), with the broader sector up 6.1% on a price-only basis. Campbell Soup Company’s dismal earnings report, and subsequent stock sell off, has weighed on the group’s performance this quarter. The company reported a sales decline of 2% and stated that earnings were negatively impacted by higher carrot prices and higher transportation costs in the quarter. An important take-away from Campbell’s and other Staples’ company results may be that their top lines are not as resilient in the modern economy as they have been in the past. The Amazon affect, farm-to-table menu preferences, healthier eating habits, and the proliferation of private label goods are all trends that are chipping away at the incumbents’ once dominant franchises. That vulnerability could call into question the high multiples that investors have awarded Staples companies in the past.
The S&P Consumer Staples sector currently trades at 19.3x 2018 calendar year earnings per share estimates, according to FactSet, for an index whose constituents are expected to generate 3.5% sales growth and 7.5% earnings growth during the period. That compares to the broader S&P 500 trading at a 17.9x P/E multiple for 5% sales growth and 11% earnings growth. Over the past 15 years the S&P Staples sector has, on average, traded at a 12% premium to the S&P 500. That premium now stands at 8%, and risks compressing further as changing consumer preferences and behaviors, and the proliferation of mature industry disruptors threaten incumbent revenue streams. Staples constituent stock prices may continue to see inflows during periods of sector rotation and flights to safety, but it is hard to make a case that Consumer Staples stocks will continue to enjoy the premium valuations they have in the past.
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