Week 22: Consumer staples sector provides stability


Week 22


The consumer staples sector provides stability to equity portfolios by providing steady growth, dividend income and low volatility.

The consumer staples sector is home to many of the products we use every day, such as toothpaste, soft drinks, diapers, and other household items.

Because of the consistent demand for the sector’s products, any disruption tends to develop over longer time periods, and any impact is often felt only at the margins. Accordingly, the sector has been a consistent performer over time. Nevertheless, there are some disruptive trends that will likely continue in 2017 and beyond, which will influence our investment approach.

For example, there has been a shift in consumer appetites toward organic, whole foods. This trend could alter the earnings growth prospects for some large packaged-food manufacturers. Companies that can respond effectively to this healthy food movement appear increasingly attractive heading into 2017.

In addition, global economic headwinds, such as currency depreciation and slower growth, have challenged multinational companies that earn a large portion of their profits abroad. However, we continue to see significant growth opportunities for consumer staples companies operating abroad.

Driven largely by millennials, consumers increasingly favor foods that are made locally, or from smaller, artisan producers (see Natural and Organic Food chart). Further, many people now prefer to buy whole, raw ingredients and prepare more of their meals at home. This trend away from processed foods could hamper the earnings of larger packaged- food manufacturers. In response, some companies have successfully changed consumers’ perception of their product lines to appear more natural and “smaller.” For example, some have acquired smaller companies and maintained the original branding that consumers have come to recognize as artisan. Others have changed the formulations of their products to eliminate certain ingredients, such as artificial colors or high fructose corn syrup.

Additionally, new companies with unique business models have emerged in the wake of this healthier food trend. For example, a handful of companies will ship all necessary ingredients, detailed recipes, and cooking instructions to consumers looking for a shortcut to prepare healthy meals at home. We continue to seek companies that effectively adjust their product lines to changing consumer preferences, or create innovative new lines of business to capitalize on emerging trends. We seek to own focused companies that sell leading brands, exhibit strong future earnings potential, and are trading at reasonable valuations.

We continue to see a massive opportunity for consumer staples companies… specifically in emerging markets. Consumers tend to buy the same amount of toothpaste and laundry detergent every year, so volumes across the sector grow roughly in line with population growth (about 1% annually). However, with incomes on the rise in emerging markets, spending on these items is growing much faster, as consumers transition from low-income status to middle class.

Consumer staples stocks can lend stability to an equity portfolio, due to the relatively consistent nature of consumer demand for their products. The sector may also appeal to income-oriented investors because its dividend yield is currently higher than the yields offered by many bonds. Unlike most bonds where interest payments are fixed, many staples stocks have successfully increased their dividends over time, as companies have grown their earnings alongside rising inflation… an attractive characteristic should inflation pick up.