CL Colgate Palmolive Co

Stocks in the Consumer Staples sector have traditionally performed better than the stock market, and especially cyclical companies, during market declines. We are seeing evidence of this at present -- consumer staple stocks have started shining again as concerns about the economy’s growth momentum have taken center stage.

The fundamental explanation for this behavior is that food, beverage, household products and cosmetics companies manufacture and market brand name consumable products, most of which are considered essential to daily life, such as food, drink, toothpaste, deodorants, toilet paper, etc.

Since product demand is relatively stable, the companies generally report earnings in line with expectations.

Beverage companies, however, are able to grow faster at the high single-digit to low double-digit rate given growing penetration rates. But, cosmetics companies can grow earnings a percentage point or two above beverage companies, because they are able to differentiate their products.

Past Performance

In 2009, the Consumer Staples sector underperformed the market as stocks had started discounting the recovery out of the Great Recession. In 2010, the sector index grew 10.7% versus a 12.8% increase for the S&P 500 index.

Given the less than clear macro-backdrop at present, the group has again come into favor, helping it do better than the rest of the market. The defensive profile of consumer staples makes it an attractive refuge in uncertain times like the present ones.

Road Ahead

As referrred to earlier, the macro-economic environment remains uncertain. With consumer spending under pressure, as reduced state and municipal spending and high gas prices offset the benefits from the payroll tax cut. As a result, domestic retail revenue growth is expected to remain relatively modest.

Further, the unemployment level in the U.S. is expected to remain high much longer than appeared to be the case a few months ago, as indicated by the disappointing May non-farm payroll report. In this environment, less expensive private label goods are expected to attract consumers, thereby limiting the growth potential of branded food companies.

Further, the substantial rise in raw material prices remains a drag on margins of most of the companies in this sector. We have seen this trend with Colgate Palmolive (CL), Kimberly-Clark (KMB) and Procter & Gamble (PG) in recent days.   

However, among soaring prices of raw materials and high levels of unemployment, there still seems to be some opportunity for companies under the consumer staples sector to cash in on. Growing awaress of issues like obesity and cardio-vascular diseases has prompted consumers to seek out healthier alternatives that have fewer calories and less sugar and sodium.

Many companies in the group, such as Campbell Soup Company (CPB), PepsiCo (PEP) and The Coca Cola Company (KO) have come out with products to tap this market demand. Similarly, even companies operating in the household products category such as Procter & Gamble and Colgate Palmolive bring out new innovative products to cater to the ever-changing demands of customers.

Health, beauty and other products targeted at Baby Boomers also remain well positioned. Products that help this generation look or feel younger may thrive as many Baby Boomers seek to continue working beyond the traditional retirement age. Companies such as Avon Products (AVP) and Unilever (UL) are constantly introducing new products especially targeted at young women.
 
In the mass retail space, the top and bottom tiers are doing fine, though the mid-market segment has remained under pressure. Among discounters, Dollar General (DG) opened 600 new stores last year and is expected to repeat this in fiscal 2011.

Similarly, Family Dollar Stores (FDO) has announced that it will increase its rate of new store openings by 50% and plans to open 300 new stores in 2011, while Supervalu (SVU)-owned Save-A-Lot has announced plans to double its store network by 2015, which would take its total network to 2400.

OPPORTUNITIES

We are more or less Neutral on the stocks in this sector. Though temporarily impacted by inflation, these companies are cash rich and can withstand the current economic headwinds. Procter & Gamble (PG) is one of the strongest and most financially sound companies in the consumer staples sector. The company generated approximately $3.2 billion in free cash flow with a free cash flow productivity of 113%.

Although the global market growth was a meager 3% for the most recently reported quarter, Procter & Gamble continues to see healthy growth rates in developing markets in the range of 6% to 8%. However, margins were impacted by higher commodity costs. Higher commodity costs compared with the year-ago quarter led to a 200 bp margin contraction in the last quarter.

In the most recent quarter, global net sales of Colgate Palmolive (CL) increased 4.5% year over year to $4.0 billion despite a 3% benefit from foreign exchange and a 2% addition from global unit volume, which was offset by a 0.5% decline in pricing.

On an organic basis (excluding foreign exchange, acquisitions and divestitures), sales increased 1.5% in the quarter, with gross profit increasing by 2.8% to $2.3 billion. Gross profit margin declined by 80 basis points to 58.4% compared with the prior-year quarter, as higher material costs and steep promotional investments undid the benefits of cost-saving initiatives.

WEAKNESSES

Kimberly-Clark (KMB) is one of the world’s leading manufacturers of health and hygiene products, and commands a strong portfolio of well-established brands. In the most recent quarter, the company reported lower than expected results. The margins were also impacted by higher costs of raw materials.

Further, the company assumes inflation to be in the range of $450 million to $550 million. The increased inflation assumption is primarily due to higher costs for virgin pulp, polymer resin and most other oil-based materials. Although, on a long term basis we are Neutral on the stock, on a short term basis the stock has a Zacks #4 Rank which implies a Sell rating on the stock.

Altria Group (MO) reported modest results for the first quarter of 2011. Although earnings grew 4.8% year over year, it was in line with the Zacks Consensus Estimate.

Further, revenues also contracted 2.0% to $5.6 billion. The decline was attributable to lower net revenues from cigarettes and cigars, partially offset by higher net revenues from smokeless products, financial services and wine. Excluding excise taxes, revenues were flat year-over-year at $3.9 billion.

Management at Altria stated that the business environment for 2011 is expected to remain challenging. This is because adult consumers remain under economic pressure and face high unemployment. In addition, Altria’s tobacco operating companies also face a number of challenges as they enter 2011.
 
AVON PRODS INC (AVP): Free Stock Analysis Report
 
COLGATE PALMOLI (CL): Free Stock Analysis Report
 
DOLLAR GENERAL (DG): Free Stock Analysis Report
 
FAMILY DOLLAR (FDO): Free Stock Analysis Report
 
KIMBERLY CLARK (KMB): Free Stock Analysis Report
 
COCA COLA CO (KO): Free Stock Analysis Report
 
ALTRIA GROUP (MO): Free Stock Analysis Report
 
PEPSICO INC (PEP): Free Stock Analysis Report
 
PROCTER & GAMBL (PG): Free Stock Analysis Report
 
SUPERVALU INC (SVU): Free Stock Analysis Report
 
UNILEVER PLC (UL): Free Stock Analysis Report
 
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