Will Economic Recovery Hurt Consumer Staples Investing?

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The consumer staples sector doesn't seem to be the perfect choice for investors right now as it is often viewed as more attractive when economic growth is sluggish. Further, if growth picks up too quickly in 2017, the Fed will have to become more aggressive with the pace of interest rate hikes. Higher U.S. interest rates will likely lead to a stronger U.S. dollar, which would pressure overseas profits and create a headwind for emerging market economies.

In fact, there are some disruptive trends that will likely continue in 2017 and beyond, which may influence investors' approaches. Last month, Organization of Petroleum Exporting Countries (or OPEC) decided to cut oil production in order to put a floor to the falling oil prices . The surge in oil prices in the coming months might significantly increase the commodity prices of staples stocks, thus increasing margin pressure. Headwinds like unfavorable currency, food deflation, potential price wars, a competitive environment and slowdown in international markets are also hindering growth.

Hence, investors should carefully select stocks for their portfolio as certain headwinds are likely to prevail in the coming months.


Food Deflation and Price Wars

The grocery/supermarket business is grappling with food deflation, stiff competition, aggressive promotional environment, and waning store traffic. These headwinds have severely impacted major food grocers like The Kroger Co. (KR), Whole Foods Market, Inc. (WFM), SuperValu, Inc. (SVU), Sprouts Farmers Market (SFM) and United Natural Foods, Inc. (UNFI).

An oversupply in some types of food - particularly meat, poultry and dairy - has dragged prices lower and forced grocery stores into more aggressive promotions. Cheaper groceries have also hurt the restaurant business, with more people opting to save money and eat at home.

Oversupply of beef, glut in poultry and egg, and a stronger dollar along with general weaker demand for dairy in Asia led to a resultant drop in commodity prices.

Analysts believe the price wars between companies will erode profits, leading to declining margins in the near term.

Slowdown in Emerging Markets

The majority of the global population lives in emerging economies. Due to a slowdown in income and consumption growth, affordability is low. Though there remains huge opportunity for sales growth in these markets, currently the state of affairs remains volatile. Apart from China, which is struggling since the past few quarters, developing countries like Brazil and Mexico are facing economic slowdown. The Middle East, Russia and Ukraine are witnessing continued political and civil unrest resulting in challenging operating conditions. Some developed markets are also facing weakness due to sluggish consumer demand.

For example, consumer product company, Unilever plc (UL) witnessed some improvement in India and more stable conditions in China last year. However, it is still struggling with declining volumes in Brazil and a soft economy in Russia. The company is also witnessing weakness in the developed markets with little sign of recovery in North America or Europe. Moreover, it still remains cautious as consumer demand continues to be weak.

Beverage giant, The Coca-Cola Company (KO) also remains apprehensive of broader economic challenges in the future quarters. While the macro-environment is improving in North America, Japan and India, Coca-Cola expects challenges in many key emerging/developing markets like Brazil, Russia and China.

Companies like Procter & Gamble Co. (PG) and Kellogg Co. (K) are also struggling with decelerating growth in the developing markets and currency headwinds. U.K.-based brewer, Diageo Plc (DEO) also faces macroeconomic headwinds and tough retail conditions in emerging markets.

Higher Operating Expenses to Limit Profits

Consumer staple companies tend to spend heavily on marketing and advertising. Though advertising strengthens brand appeal and helps to counter competition, it severely hits the profit margins of these companies. Companies like Kimberly-Clark Corp. (KMB), PepsiCo Inc. (PEP) and Procter & Gamble have significantly stepped up their investments in marketing, innovation, R&D, supply chain and capacity additions, which will weigh on profits in the short term. Pinnacle Foods, Inc. (PF) incurs higher expenses as a result of innovation and promotional activity.

Increased Competition

Some of the Consumer Staples companies are impacted by rising competition due to the growth of low-cost, emerging-market production. This is resulting in shrinkage of pricing power and decline in market share, which in turn are compressing margins and squeezing earnings.

For example, Kimberly-Clark's diaper segment is witnessing lower market share and higher competitive promotional activity, as its Huggies diapers are competing with Procter & Gamble's cheaper Luvs and upscale Pampers offerings. The J.M. Smucker Co.'s (SJM) mainstream Pet Food business is also facing heightened competitive activity and challenges in dry dog food amid a deflationary macro environment, which is impacting the performance of its Kibbles 'n Bits brand.

Unfavorable Foreign Currency Impact

Companies, which have a significant presence in the emerging markets, are being affected by currency headwinds, given the weakening of many emerging market currencies against the U.S. dollar.

Foreign exchange is a major headwind for companies like Estee Lauder Companies, Inc. (EL), Mondelez International, Inc. (MDLZ), General Mills, Inc.(GIS), Kimberly-Clark, Unilever, and PepsiCo, which have significant business outside the U.S. Venezuelan currency issues are also hurting Nu Skin Enterprises, Inc.'s (NUS) earnings significantly.

Declining Volumes

Many consumer staples companies are struggling with declining volume or soft volume growth, which is hurting their top line.

For example, tobacco companies like Altria Group, Inc. (MO), Philip Morris International, Inc. (PM) and Reynolds American, Inc. (RAI) are facing declining shipment volumes mainly due to anti-tobacco campaigns & general shifting from cigarettes and cigars to alternative tobacco products such chewable nicotine, e-cigarettes, heat stick. The government has imposed higher excise taxes on cigarettes, as a result of which tobacco companies are increasing prices. Further, rising competition from fake versions of branded cigarettes by local retailers is also hurting cigarette volumes.

Volumes of food company, Mondelez International have been hurt by the elasticity impact from higher pricing and category weakness because of soft consumer demand.

Beverage companies like Dr. Pepper Snapple Group Inc. (DPS), Coca-Cola and PepsiCo (PEP) have also been seeing declining volume trends in their carbonated soft drinks businesses due to category weakness. Muted volume trend will remain a concern going forward.

Bottom Line

As is evident, there are plenty of concerns in the consumer staples industry. However, when it comes to investing in the space right now, are there any opportunities for short-term investors?

Check out our latest Consumer Staples Outlook for more on the current state of affairs in this market from an earnings perspective and the trend in this important sector of the economy.

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Whole Foods Market, Inc. (WFM): Free Stock Analysis Report

United Natural Foods, Inc. (UNFI): Free Stock Analysis Report

Unilever PLC (UL): Free Stock Analysis Report

SuperValu Inc. (SVU): Free Stock Analysis Report

J.M. Smucker Company (The) (SJM): Free Stock Analysis Report

Sprouts Farmers Market, Inc. (SFM): Free Stock Analysis Report

Reynolds American Inc (RAI): Free Stock Analysis Report

Philip Morris International Inc (PM): Free Stock Analysis Report

Procter & Gamble Company (The) (PG): Free Stock Analysis Report

Pinnacle Foods, Inc. (PF): Free Stock Analysis Report

Pepsico, Inc. (PEP): Free Stock Analysis Report

Nu Skin Enterprises, Inc. (NUS): Free Stock Analysis Report

Altria Group (MO): Free Stock Analysis Report

Mondelez International, Inc. (MDLZ): Free Stock Analysis Report

Kroger Company (The) (KR): Free Stock Analysis Report

Coca-Cola Company (The) (KO): Free Stock Analysis Report

Kimberly-Clark Corporation (KMB): Free Stock Analysis Report

Kellogg Company (K): Free Stock Analysis Report

General Mills, Inc. (GIS): Free Stock Analysis Report

Estee Lauder Companies, Inc. (The) (EL): Free Stock Analysis Report

Dr Pepper Snapple Group, Inc (DPS): Free Stock Analysis Report

Diageo PLC (DEO): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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