Stocks in the Consumer Staples sector have carried out their
traditional defensive role despite concerns about the prolonged
weak US economy and the debt crisis in Europe. Year to date
(through June 22, 2012), shares of consumer staples companies,
accounting for about 9% of the S&P 500 Index by market
capitalization, were up 4.5%, compared with a 6.2% gain for the
S&P 500. In 2011, the sector index grew 10.5% versus flat
growth for the S&P 500 index.
The group's defensive attributes stem from its ability to resist
sluggish economic growth, as food, beverage, household products and
cosmetics companies that manufacture and market non-durable
consumables such as food, drink, toothpaste, deodorants, toilet
paper, etc., are essential parts of daily life.
Top-Lines Growing, Volumes Declining
Most of the consumer companies are enjoying an upside in their top
lines, driven mainly by pricing gains, though volumes are still
suffering. Volumes are suffering mainly due to constrained consumer
spending, especially in the developed nations of North America and
Europe. However, there are some exceptions like
Kraft Foods Inc.
H.J. Heinz Company
), which have reported volume increases in Europe despite the
severe economic challenges.
Moreover, significant price increases of products are also hurting
volumes. However, companies like Kraft Foods,
The Hershey Company
) have successfully raised prices while maintaining positive volume
Input Cost Inflation Hurting Margins
Continuously rising commodity and other input costs are pulling
down the margins for most of these companies, despite top-line
growth. Thus, these companies are resorting to price increases and
cost-cutting measures to negate the inflated input costs.
Therefore, to survive in an environment where input costs are
trending higher, many companies in the consumer staples sector have
"right-sized" portions and packages of their products to pass the
burden of higher prices to consumers. For example: Heinz has
introduced economical pouches, doy packs for most of its popular
ketchup and sauces making it an affordable option for smaller
However, the companies are optimistic that commodity cost inflation
will slowdown in the second half of 2012.
Cost Reduction Initiatives
In an effort to boost long-term growth and reduce the effects of
inflating commodity costs, most consumer staples companies have
undertaken several strategic initiatives like divesture of
low-margin brands, improvement of supply chain and implementation
of cost-reduction initiatives.
The Coca-Cola Company
) is undertaking various productivity initiatives to streamline its
cost structure and boost profitability. In February 2012, it
launched a four-year productivity and reinvestment program, which
includes initiatives like optimization of global supply chain;
improving effectiveness of global marketing and innovation;
operating expense leverage; standardization of information systems
and integration of Coca Cola Enterprises' North America business
that was acquired in 2010. The program is expected to generate
incremental annualized savings of $550 to $600 million phased over
a four-year period starting in 2012 through the end of 2015.
) restructuring program is expected to result in more than $1
billion in productivity in 2012 and a total of $3 billion over the
next three years. The program will include leveraging new
technologies and processes across operations, consolidating
facilities, simplifying organization structures, lowering layers of
management, workforce reduction of 3% and many more efforts. The
program is expected to lower the company's cost structure, thereby
freeing up resources to invest in innovation and brand building.
Altria Group Inc.
) completed the cost reduction plan for the period of 2007 to 2011
very recently. It further initiated a new $1 billion cost reduction
program in the third quarter of 2011, which is expected to deliver
$400 million in annualized cost savings by the end of 2013. The
company also reduced its workforce by 700 employees in February
2012 as a part of its restructuring program to reduce cost.
Another tobacco seller,
Reynolds American Inc.
), recently completed its business analysis and in the process has
identified resources to reinvest in the businesses to sustain their
growth momentum. The business analysis was focused on the ways to
reduce cost, and the company has decided that by eliminating
surplus labor the company will be able to generate savings of about
$25 million associated with the workforce restructuring by year-end
2012. Those savings will increase to about $70 million annually in
The world's largest saucemaker, Heinz, invested in productivity
initiatives in the just-completed fiscal year by increasing
manufacturing efficiency, reducing overcapacity and streamlining
its operations. In addition, the company is also investing in
Project Keystone, a multi-year program aimed at increasing Heinz's
competitiveness by adding capabilities, improving processes and
systems through SAP.
Management believes the project, which is focused primarily in
Europe, will optimize the company's sales mix, increase
manufacturing efficiencies and improve costs. Cost-saving endeavors
like these would help counter the impact of rising commodity costs
and prepare the foundation for long-term growth.
Expansion Beyond U.S. Markets
With the economic environment being sluggish in the developed
nations, demand has remained relatively stable for companies that
are more exposed to developing countries, especially the
fast-growing emerging markets. Developed nations are witnessing
volume declines due to market saturation, low disposable incomes of
consumers and competitive activity. However, their developing
counterparts such as China, Brazil, India, Mexico, Russia and
Southeast Asia boast positive consumer spending growth.
These developing countries are receiving greater support in terms
of infrastructure investment and marketing outlays. Demand for
convenient and branded packaged food is growing, as middle-class
consumers in these countries shift to urban living. Thus, the
rising pool of middle class consumers in emerging markets
represents a huge opportunity for branded consumer companies.
Beverage companies such as Coca-Cola and PepsiCo are showing
interest in the emerging markets of India, Russia and China, as the
developed markets are nearing saturation.
Coca-Cola has already invested over $2 billion in India over the
last 18 years and remains very optimistic about its Indian
operations. Further, Coca-Cola has seen a double-digit growth rate
in India aided by its top-brands, which includes Thums Up, Sprite
and Maaza. Over the next five years, Coca-Cola, along with its
bottling partners, is poised to make a further investment of $2
billion to build consumer marketing, infrastructure and brands in
The company also has plans to invest $4 billion in China over three
years starting in 2012, thus raising Coca-Cola's total investment
in China between 2009 and 2014 to $7 billion. Coca-Cola also plans
to invest $3 billion in Russia between 2012 and 2016 and $8 billion
in Brazil through 2016.
PepsiCo has invested $700 million in India since 2008. It also
plans another $500 million investment over the next three years.
Further, with the acquisition of Wimm-Bill-Dann in September 2011,
Pepsi took control over the largest food-and-beverage business in
Russia, bringing the company closer to its strategic goal of
building a $30 billion nutrition business by 2020.
Pepsico's strategic alliance with leading Chinese food and beverage
maker Tingyi Holding Corp. has created the number one liquid
refreshment beverage (LRB) manufacturing network in China, and is
expected to help PepsiCo to revamp its Chinese business.
Kraft Foods acquired Britain-based chocolates and confectionary
company Cadbury in 2010. The acquisition opened new sales channels
for the company through its vast distribution networks in
developing markets such as India, Brazil and Mexico. Kraft's brands
like Oreo cookies and Tang powdered drink mix have also created its
own space in India. Kraft's developing market segment was the
strongest performing segment for the company in 2011 and is
expected to be the key growth driver in 2012.
Heinz has a significant presence in India, China and Indonesia.
Heinz products, especially ketchup, sauces and infant nutrition
goods, are showing healthy growth in all of these markets due to
brisk demand. Management estimates that almost a quarter of the
ketchup and sauces business is now in the emerging markets led by
ABC, Master and Heinz Ketchup.
Coffee giant Starbucks Corporation's business in China is rapidly
growing, and the region is expected to become the company's
second-largest market by 2014. Starbucks is also looking to enter
the Vietnam market in September and the lucrative Indian market
with a store expected to be opened by the end of calendar 2012.
However, the companies find it difficult to maintain a favorable
volume-price mix in the emerging markets where they cannot raise
prices given the low standard of living compared to the developed
Consumer product companies necessarily need to innovate and upgrade
their brands to create differentiated value propositions for their
customers in order to remain successful.
Pepsi's low calorie cola, Pepsi Next, launched recently and is off
to a good start. The company also utilizes new packaging to shift
consumers to more profitable purchases. Its 24-ounce can for
regular and diet Dew is generating good customer response.
Contribution from the new products to the total revenue is expected
to double globally in 2012. Pepsi will increase its advertising and
marketing spending from 5.2% to 5.7% of revenues in 2012. The brand
investments are expected to boost revenue growth and also enable
increased price realization in the long run.
In the last quarter, Coca-Cola also introduced a wide variety of
brands like Coke-Zero in Uganda and Fanta Powder in India; and
beverage products like Frugos Sabores Caseros juice in Latin
America and Real Leaf green tea-based drink in Vietnam.
Starbucks has also been active to meet the needs of the
increasingly health conscious Americans. In March 2012, Starbucks
opened its first Evolution Fresh juice store in Bellevue,
Washington, and also launched a new energy drink, Starbucks
Refreshers, made from real fruit juice and green coffee extract, in
select grocery stores.
In the same month, the company announced plans to launch the
Verismo system by fall of 2012. Verismo is a premium machine which
will allow customers to prepare Starbucks-quality espresso and
coffee drinks at home. This machine is expected to help Starbucks
capture a significant share of the fast growing premium single
serve market. In January 2012, the company launched Blonde Roast
coffee in US and Canada for consumers who prefer a light roasted
J.M. Smucker Company
) recently announced plans to branch out into specialty nut
butters. It also plans to launch chocolate and mocha cappuccino
varieties of Jif hazelnut spreads in early fiscal 2013.
The tobacco sector has also been active in upgrading their
products. In the last quarter, Reynolds launched new mint flavors
for the Camel brand of smokeless tobacco like Camel SNUS to adapt
to changing tobacco usage patterns, offering adult tobacco
consumers with innovative, smoke-free tobacco products. Its
subsidiary American Snuff launched natural premium-style cigarettes
under its flagship brand.
We do not have an Outperform recommendation on any consumer staples
companies. However, companies like Hershey, Starbucks, Coca Cola
) are showing impressive improvement despite industry headwinds.
The Hershey Company reported impressive first quarter with solid
sales and profit growth. The company also upped its guidance for
fiscal 2012. Moreover, the company's strong brand positioning,
strategic marketing investments in core brands, disciplined
innovation, and consumer capabilities make it attractive. However,
higher ingredient costs and lack of significant presence outside
U.S. keep us on the sidelines. The stock carries a Zacks #3 Rank
(short-term Hold rating).
Starbucks Corporation also delivered better-than-expected second
quarter of fiscal 2012 earnings and raised its fiscal 2012 outlook
backed by improving business trends and strong first half results.
Overall, we are encouraged by Starbucks' strong market standing,
new product launches, rapid growth in China and the flourishing
Channel Distribution segment as well as solid turnaround in its
U.S. business. The stock also carries a Zacks #3 Rank.
Coca-Cola's delivered solid revenue and volume growth in the first
quarter of 2012, which made up for margin declines. We are
encouraged by the company's global reach, strong brand power,
expanding presence outside the U.S. and its solid cash position.
Moreover, the company's acquisition of Coca-Cola Enterprises'
bottling business and its productivity initiatives are expected to
result in significant cost savings.
Share buybacks continue to be significant and the company aims to
buyback substantial amount of shares in 2012. The company has also
increased its dividend rate for 50 consecutive years. The stock
carries a Zacks #3 Rank.
Walmart Stores' first quarter 2013 earnings beat both the Zacks
Consensus Estimate and the prior-year earnings. The first quarter
2013 results also surpassed the company's guidance on the back of
top-line growth. Improved traffic and product offerings resulted in
strong comp sales during the quarter.
Moreover, Walmart is the sixth-largest Internet retailer. The
company is focusing to expand its presence in online business,
which is already strong in the US, UK, Canada and Brazil. The stock
carries a Zacks #2 Rank (short-term Buy rating).
We advise investors to avoid names that have reported earnings
declines in the latest quarter. These consumer goods companies also
show signs of slackening profitability.
) first quarter 2012 earnings missed the Zacks Consensus Estimate
and the prior-year quarter earnings due to decline in top line,
high commodity costs and investments in supply-chain initiatives.
Revenues declined due to the sluggish European business and
weakness in the U.S. cereal category. The company slashed its 2012
financial outlook following the weak start to the year. The stock
carries a Zacks #3 Rank.
The consumer goods giant
Procter & Gamble Company
) also reported dismal third quarter fiscal 2012 results. The
adjusted earnings were flat with prior-year levels as benefits from
top-line growth and cost savings were offset by rising commodity
costs. Moreover, the company cut its earnings outlook for fiscal
2012 due to Venezuela price regulations, rising input costs and
economic uncertainty in Western Europe and U.S. The stock carries a
Zacks #5 Rank (short-term Strong Sell rating).
Smithfield Foods Inc.'s
) operating margins also suffered on the back of increased prices
in the hog market. Though the management has undertaken cost saving
initiatives, the rising prices of raw materials are offsetting the
benefits from these initiatives in the near term. Feed grains,
including corn, soybean meal and wheat prices, which are the
company's primary raw materials, have fluctuated and escalated in
recent years due to increased worldwide demand.
We expect the rising costs of raw materials to pull down the
company's margins significantly in the future. Moreover, widespread
anti-obesity campaigns in U.S. have resulted in a general shift of
consumer's preference away from meat products. The stock carries a
Zacks #3 Rank (short-term Hold rating).
Iconix Brand Group
) continued to witness weak demand for men's apparels. This
compelled the company to chop its revenue and earnings guidance for
fiscal 2012. The company projects lower revenue from these brands
in 2012 versus 2011 levels. The transfer of the Royal Velvet brand
) is also expected to negatively impact fiscal 2012 revenues. The
stock carries a Zacks #3 Rank (short-term Hold rating).
HEINZ (HJ) CO (HNZ): Free Stock Analysis Report
HERSHEY CO/THE (HSY): Free Stock Analysis
KELLOGG CO (K): Free Stock Analysis Report
KRAFT FOODS INC (KFT): Free Stock Analysis
COCA COLA CO (KO): Free Stock Analysis Report
ALTRIA GROUP (MO): Free Stock Analysis Report
PEPSICO INC (PEP): Free Stock Analysis Report
REYNOLDS AMER (RAI): Free Stock Analysis Report
STARBUCKS CORP (SBUX): Free Stock Analysis
SMUCKER JM (SJM): Free Stock Analysis Report
WAL-MART STORES (WMT): Free Stock Analysis
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