Coca-Cola and 6 other consumer-staples stocks that still have upside

  • By Daren Fonda,
  • Barron's
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It’s hard to get stoked about a sector with weak earnings growth and pricey valuations. But consumer staples, despite those unfavorable traits, have managed to outperform the market this year. And while the sector isn’t “safe,” at least by historical standards, there are still some attractive stocks in the space, according to Bernstein Research analyst Ali Dibadj.

The staples sector has gained 19.9% this year, edging out most other sectors in the top 1,500 universe of stocks and the S&P 500’s (.SPX) 19.7%. The stocks appear to be rising almost entirely due to multiple expansion, or rising price/earnings ratios, rather than forecast earnings growth.

Indeed, Dibadj attributes almost all of the sector’s return to multiple expansion, with just 0.6% coming from a change in earnings forecasts, according to a note he put out on Thursday.

Rising multiples have pushed the sector’s P/E to about 20 times forward earnings, a 9% premium to the market. That’s in line with the sector’s historic premium. But it’s coming with more earnings volatility, especially in the packaged food and beverage sectors.

“I think it’s tough to get excited on a fundamental basis about the sector,” Dibadj said in an interview with Barron’s.

But fundamentals aren’t necessarily driving the stocks. The sector has long benefited from a flight to safety as investors worry that a downturn is coming or that the bull market will come to an end. The sector is also responding to lower interest rates, which tend to lift dividend-oriented stocks. Says Dibadj: “A rate cut would be good for companies like these.”

While the sector might look risky from a fundamental perspective, it is still home to large, multinational companies with enormous balance sheets and the financial means to orchestrate growth. Even without rising sales, companies can cut costs, make acquisitions, and buy back shares to boost earnings.

Moreover, the sector isn’t uniformly hobbled by lackluster growth and bloated cost structures. It’s home to innovative companies like Estée Lauder (EL), whose chief executive, Fabrizio Freda, has made Barron’s list of Best CEOs for two years in a row. As my colleague Reshma Kapadia reported, Fabrizio “has chiseled away at costs, more than doubled operating profits, and positioned the company for the future by targeting online and emerging-market growth.”

In a tough competitive environment, Dibadj recommends avoiding commodity-oriented stocks and sticking with those that can maintain prices, capture cost savings, or benefit from other growth drivers like innovation or “marketing prowess.”

“There are opportunities for Coca-Cola (KO), PepsiCo (PEP), and Procter & Gamble (PG) to grow EPS in the high single- to low double-digit range,” he says. “Commoditized companies like Clorox (CLX) will be under more pressure.”

Dibadj and his team have Outperform ratings on Coca-Cola, PepsiCo, P&G, and Estée Lauder. They also have Buys on Hershey (HSY), Mondelez International (MDLZ), and Tyson Foods (TSN).

Conversely, they don’t see much opportunity in the cereal aisle, rating Kellogg (K) and General Mills (GIS) Underperform. And they see scant upside in other packaged-food stocks, including Conagra Brands (CAG), J.M. Smucker (SJM), and Campbell Soup (CPB), all rated Underperform.

Granted, Buy ratings don’t necessarily imply big gains in this sector. Dibadj’s price target on Coca-Cola is $53, slightly above the stock’s closing price of $52.04 on Thursday. P&G closed at $114.38, above his target of $113. Estée Lauder closed at $186.08, just 3.2% below his target of $192; Tyson closed at $81.43, 10.5% below his target of $90.

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