Outlook For Consumer Staples Stocks May Improve In 2010

Consumer staples stocks, which fell out of favor with investors for much of this year, may do better in 2010.

The stability of the so-called staples--companies that make everyday necessities like packaged food, garbage bags, toothpaste and soft drinks--lost their appeal as credit eased, global economies picked up and riskier stocks looked more attractive. But some investors believe the early euphoria of a recovery will moderate and interest rates will eventually climb, turning these makers of daily household goods into more attractive investments.

Consumer product manufacturers will keep facing pressure from cheaper store brands and from retailers being more tightfisted with their shelf space. But the big household brands still have strong cash flows and an international presence that could help offset some of those negative aspects.

Large branded consumer manufacturers including Coca-Cola Co. (KO) and Procter & Gamble Co. (PG) draw large parts of their revenue overseas from countries like India and China that stayed resilient in the global recession. If interest rates climb, these manufacturers' strong balance sheets will allow them to borrow at attractive terms even as riskier businesses face higher costs on their debt. The strong cash levels also allow for fatter dividends and share buybacks.

"These are global names that people tend to see as a little safer," says Walter Todd, a portfolio manager at Greenwood Capital. "There is a lot of uncertainty about when the (Federal Reserve) is going to raise rates. In the first half of next year we are going to see some migration into more defensive areas like consumer staples." Greenwood Capital holds shares of consumer staples including PepsiCo. (PEP), Procter & Gamble and Kellogg Co. (K).

With just a few more trading days left for the year, the consumer staples sector is up 13% for 2009, lagging the 25% gain of the broad Standard & Poor's 500 index.

But Goldman Sachs analysts in a recent research brief said they expect consumer staples stocks to at least keep pace with the broader market. In fact, they found the sector tends to moderately outperform at this stage of the business cycle when the Institute of Supply Management index, a key measure of manufacturing activity, is above 50 and rising.

Consumer staples companies are likely to be able to increase their earnings, particularly since commodity prices are off their peaks. Goldman expects per share earnings to rise 11% for the sector in 2010, a faster rate of earnings growth than this year and about 1% to 2% above the consensus expectation. Goldman analysts say that among their top large-cap picks are Philip Morris International Inc. (PM), Coca-Cola Co. (KO) and Colgate-Palmolive Co. (CL), all companies poised to benefit from a recovery in emerging markets.

Bill Hackney, chief investment officer at Atlanta Capital, says his firm holds shares of Coke and Procter & Gamble.

"The thing about these companies is they are not dependant on the debt markets for growth. They throw off lots of free cash flow," Hackney says. That could help the staples sector by the middle of next year, by which time he expect concerns about higher taxes and interest rates to start weighing on investors minds. Tax cuts from the Bush-era expire at the end of 2010.

That said, consumer manufacturers will have their share of troubles, particularly pressures from retailers pushing them to lower prices and offer more promotions. Sales could be tepid if consumers stay cautious and unemployment remains elevated. Price competition could heat up. Goldman cut its 2010 earnings per share estimates on Campbell Soup Co. (CPB) and Kellogg Co. (K) by 2% due to concerns of tougher competition.

Some investors are staying cautious on the sector because sales have been increasing at a fairly muted pace. David Klaskin, chief investment officer for Oak Ridge Investments, says his firm is staying underweight on staples stocks. "They are fairly expensive for their growth rates," he says.

-By Anjali Cordeiro, Dow Jones Newswires; 212-416-2200; anjali.cordeiro@dowjones.com

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