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State of the consumer staples sector

These stocks generally appear slightly cheaper than the broader U.S. market.

  • By Robert Lee, Portfolio Manager,
  • Asset Management
  • – 10/23/2013
  • Consumer Staples Sector
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Business conditions in the consumer staples sector generally have remained fairly stable during the past six months. There have been few instances of extreme pricing competition or price wars. Commodity input costs have been reasonably stable, which is ideal for staples manufacturers because it allows them to better manage their costs and earnings expectations.

There has been a modest deceleration in the underlying sales growth experienced by many staples companies so far in 2013 (see Earnings Scorecard below, right), but the growth rates are still within the range of growth seen during the past several years.

Strengthening dollar a headwind

Throughout the past couple of years, the strengthening of the U.S. dollar relative to foreign currencies has had a negative impact on the year-over-year earnings growth of U.S.-based consumer staples companies with multinational operations (see the chart below).

The weakening of foreign currencies relative to the U.S. dollar causes the foreign earnings of U.S. companies to decline in U.S. dollar terms, which are how they are reported by the companies. During the first half of 2013, I believe the U.S.-dollar’s strengthening did contribute to the uninspiring earnings growth in the sector, and it helped cause staples companies in aggregate to miss the market’s expectations in the second quarter.

The consumer staples sector is one of the sectors, including information technology and health care, that tend to generate a significant percentage of overall profits from their overseas operations. At the same time, investors should keep in mind that while the impact of currency movements can influence the profitability of multinational companies over any short-term period, this impact tends to wash out over an intermediate-term because currencies historically have tended to rise and fall in a cyclical fashion.

Looking ahead to the third quarter, Wall Street analysts are currently anticipating a 4.2% rate of quarterly earnings growth, which is down from expectations of 8.3% entering the quarter on July 1, 2013.1

New product innovation in tobacco

Many investors who are willing to invest in stocks of tobacco companies have become interested in the development of electronic cigarettes. These products, which are promoted as potentially “healthier” alternatives to traditional cigarettes, have gained sales momentum over the past few years and now represent approximately one percent of the industry’s sales.

At present, the manufacturing and distribution of these new products is fairly fragmented, as several companies are involved, including both the major existing tobacco companies as well as newer, much smaller firms. If these products continue to take market share over time, I would expect at some point to see consolidation among the manufacturers.

Assessing valuation

Stock valuations in the consumer staples sector were reasonable at the end of the third quarter of 2013. The sector’s price-to-earnings ratio (forward earnings) stood at 16.8 as of Sep. 30, 2013, roughly in line with its long-term average of 17.0 (see the chart below). Comparing this valuation ratio to that of the broader U.S. equity market (15.9 P/E), stocks in the consumer staples sector are about 6% more expensive than the equity market as a whole, but that is modestly below the 10% premium the staples sector has historically averaged.

Investors using valuation as a tool for investment decision making should keep in mind that consumer staples stocks have tended to trade at modest premiums to the stocks in other sectors, due to the historically more attractive balance of earnings growth and consistency that businesses in the staples sector have generated.

During periods when investors are unusually fearful and risk averse, they tend to put a higher-than-normal value on the perceived safety of staples-sector stocks, and the relative valuation premium for the sector can be higher than normal. On the other hand, during periods of investor optimism and complacency, they tend to assign less value to the perceived safety of staples sector stocks, and the relative valuation premium for the sector typically can be lower than normal.

Today, the sector’s current valuation, which is roughly in line with its historical average versus the broader market, is a sign that investors’ current levels of optimism/pessimism are fairly well balanced.

Outlook for consumer staples stocks

Back to basics

Emerging markets are a potential boon for stocks in the consumer staples sector.
Read the article.

So far, 2013 has turned out to be a fairly typical year for consumer staples. With the exception of the negative influence of currency movements on corporate profits, business conditions generally have remained favorable for U.S.-based consumer staples companies. I continue to expect the sector to average high single-digit earnings growth over time, which together with its current 2.5% to 3% dividend yield would be supportive of shareholder returns if history is a guide. Most companies have the desire and the ability to raise their dividend payouts each year, and I don’t foresee any reason to believe otherwise.

During the past few months, there have been signs that the global economy will continue its modest growth trends, with some signs of improvement in foreign developed markets and potential stabilization in China. An environment featuring stable global economic growth tends to be favorable for the sales and earnings outlook for consumer staples companies.

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Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
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Past performance is no guarantee of future results.
Because of their narrow focus, investments in a single sector tend to be more volatile than investments that diversify across many sectors and companies.
The consumer staples industries can be significantly affected by demographic and product trends, competitive pricing, food fads, marketing campaigns, environmental factors, governmental regulation, the performance of the overall economy, interest rates, and consumer confidence.
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1. Expected earnings growth rate of 8.3% as of June 30, 2013; expected rate of 4.2% as of Oct. 3, 2013. Source: FactSet as of Oct. 3, 2013.
MSCI U.S. Investable Market 2500 Index represents the investable universe of companies in the U.S. equity market. Consumer staples companies of the MSCI U.S. IMI 2500 are classified in accordance with the Global Industry Classification Standard (GICS®).
Fidelity Top 3000 Stock Index: the 3000 largest stocks based on market capitalization.
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