The recent rebound in oil prices, encouraging employment picture, along with a gradual improvement in the manufacturing sector and housing market signal that the economy is in recovery mode.

The improving economy is also supported by the GDP rate provided by the Commerce Department in consumer spending for the third quarter. GDP rose at an annualized rate of 3.5% in the third quarter of 2016 (three months ending in September), up from the second-quarter anemic increase of 1.4% and better than 3.2% expansion in the second estimate.

Consumer confidence surged for a second consecutive month after a dismal show in October, indicating that the economy is on the recovery path. The consumer confidence index, which had increased to 109.4 in November, further improved in December and now stands at 113.7. Additionally, the expectations index improved from 94.4 in November to 105.5. The index surged as consumers expect a positive view of the labor market. Given an improving labor market, we expect consumer spending to improve. 

A rise in wages will also increase household wealth and eventually boosted consumer spending. A number of retailers and fast food chains, including Wal-Mart Stores, Inc. (WMT Quick QuoteWMT - Free Report) , McDonald's Corp. (MCD Quick QuoteMCD - Free Report) , Target Corp. (TGT Quick QuoteTGT - Free Report) and The TJX Companies, Inc. (TJX Quick QuoteTJX - Free Report) have hiked wages.

Oil prices are rising, but are currently somewhat lower, which will ease consumer spending power, which accounts for more than two-thirds of U.S. economic growth.

Performance of Consumer Staples Sector

The economic activity is gradually picking up steam, the employment picture is good enough and much of the political uncertainty is also resolved after the December Fed rate hike and Presidential election, leading to an overall air of optimism.

However, there remains continued uncertainty over the pace at which the Federal Reserve will raise short-term interest rates. Currency fluctuations and other global headwinds might also dent the performance of these companies. Given such headwinds, the staples sector seems to be a quite reliable and attractive area to invest in.

Now let’s discuss some of the key factors that have been driving consumer staples stocks since the past few quarters, despite global worries, and also have the potential to boost earnings in the near term.

OPPORTUNITIES

Innovations

Consumer product companies regularly innovate and upgrade their brands to create differentiated value propositions. In fact, companies with innovative products in their pipeline will be in a position to benefit.

Innovation has been a driving force for consumer product giants like The Procter & Gamble Co. (PG Quick QuotePG - Free Report) and cereal maker General Mills Inc. (GIS Quick QuoteGIS - Free Report) . P&G believes that consistent product innovation, supported by strong marketing and commercialization, will help deliver stronger results over the long term.

Global brewer Molson Coors Brewing Co. TAP has also been launching new products to boost revenues and market share. These also help it to offset the impact of declining volumes. Molson Coors also invests in marketing and advertising to create brand awareness.

Transition to Health and Wellness and ‘Good-for-You’ Products

Consumer staples companies are also shifting focus to make healthier and nutritious products in view of increasing health consciousness, rising obesity concerns and growing regulatory pressure.

Food companies B&G Foods, Inc. BGS and General Mills have been rolling out a variety of nutritious products. Natural and organic food/beverages maker The WhiteWave Foods Company WWAV, J&J Snack Foods Corp. JJSF and United Natural Foods, Inc. UNFI have been benefiting from strong demand for natural/organic food products and expect the trend to continue.

Pinnacle Foods Inc. PF acquired Boulder Brands, Inc. in Jan 2016 in order to meet changing consumer tastes, which lean toward healthier offerings. The company also aims to expand its presence in the natural and organic retail channel.

The global leader in spices and seasonings, McCormick & Co., Inc. MKC, is also reshuffling its portfolio to increase the amount of organic herbs and spices amid the rising demand for organic food products. It now plans to ramp up its organic and non-GMO offerings by 2016.

America’s largest soft drinks makers -- The Coca-Cola Company (KO Quick QuoteKO - Free Report) , PepsiCo, Inc. PEP and Dr Pepper Snapple Group, Inc. DPS -- are also shifting toward healthier and nutritious products. Accordingly, the companies agreed to promote bottled water, no-or-lower-calorie beverages and smaller portion sizes to its consumers.

Coca-Cola is growing its portfolio through acquisitions and investment in the non-alcoholic beverage industry. Pepsi is also working to expand the range of its nutritious product offering with health benefits like reduced calorie beverages, non-carbonated beverages as well as healthier snacks.

Food and beverage companies are not the only ones trying to shift to healthier options. Tobacco companies like Altria Group Inc. (MO Quick QuoteMO - Free Report) and Reynolds American Inc. are also adapting to the evolving needs of consumers and have resorted to less harmful alternatives like electronic cigarettes (e-cigarettes).

In line with this trend, Philip Morris International, Inc. (PM) is working on its portfolio of e-cigarette products called Next Generation Products. These products generate nicotine-containing aerosols by heating a liquid. These will reduce the risks related to tobacco products and attract adult consumers. Philip Morris also focuses on the development and scientific assessment of non-combustible alternatives to cigarettes, which are referred to as Reduced-Risk Products (RRPs) as they have the potential to reduce the risk of smoking-related diseases.

Acquisitions and Strategic Partnerships

Consumer staples companies are regularly undertaking acquisitions both domestically and internationally to expand their existing customer base and product lines into new markets. Some of them are also forming partnerships, mostly with larger and better known companies, to take a lead in this challenging environment.

Tyson Foods’ merger deal with packaged meat producer, The Hillshire Brands Company in Aug 2014 was the most talked about and the biggest deal in the meat industry. The Jun 2015 merger of Reynolds American – Lorillard in the tobacco industry was also of a similar scale. Another big merger that happened in Jul 2015 was that of Kraft Foods Group, Inc. and H.J. Heinz Company per a deal announced in March. The entity formed, The Kraft Heinz Company KHC, is now the fifth-largest food and beverage company in the world.

Belgium-based brewer Anheuser Busch InBev BUD acquired London-based rival SABMiller plc SBMRY in another mega deal. With the completion of this merger, in Oct 2016, Molson Coors acquired SABMiller plc’s 58% stake in MillerCoors, which is a joint venture of Molson Coors and SABMiller formed in 2008 and sells both companies' products in the U.S. Molson Coors had 42% stake before the acquisition.The deal makes Molson Coors the largest brewery in the U.S. and the third largest in the world, after Belgium-based Anheuser-Busch InBev and Dutch brewer Heineken NV HEINY.

 Acquisitions have also backed growth of the companies in the space. Treehouse Foods Inc. THS, which was spun off by Dean Foods Company DF, has been expanding its product offerings through a number of acquisitions. The acquisition of Private Brands business in Feb 2016 from ConAgra Foods, Inc. CAG generated significant revenues for the company.

Notably, Unilever plc (UL Quick QuoteUL - Free Report) has been on an acquisition spree since the last few quarters. In Dec 2016, the Anglo-Dutch buyer announced the acquisition of Living Proof Inc., the innovative premium hair care business. This was followed by the acquisition of Vermont-based Seventh Generation Inc. in Sep 2016. Then Unilever expressed interest in buying Honest Co., a company co-founded by actress Jessica Alba, which sells disposable baby diapers and other baby products. In Aug 2016, Unilever announced the acquisition of Stockholm-based Blueair. Also, Unilever completed the purchase of Dollar Shave Club for about $1 billion, which was announced in Jul 2016.

United Natural has also been carrying out various acquisitions over the years to grow its distribution network, customer base and boost long-term growth. In 2016, United Natural acquired Gourmet Guru (August), Haddon House Food Products (May) and Nor-Cal Produce, Inc. (April).

Divestitures

The companies are also focusing on improving their product portfolio through divestitures, which enables them to concentrate on their core portfolio. For example, Iconix Brand Group, Inc. ICON is focusing on managing its portfolio and spending resources on businesses that generate significant volume through both direct-to-retail relationships and global networks. In line with the view, on Dec 30, 2016, Iconix Brand sold the rights to the Sharper Image brand and related intellectual property assets to ThreeSixty Group, the brand's largest licensee, for $100 million in cash. Sharper Image is the second brand to be divested in 2016, the other being Badgley Mischka. Iconix Brand sold the rights for Badgley Mischka IP to Titan Industries, Inc. for $16 million cash in March.

On Dec 6, SUPERVALU Inc. completed the divestment of its Save-A-Lot business to private equity firm Onex for $1.365 billion in cash. SUPERVALU had announced its intention to spin off Save-a-Lot stores a year ago. The sale of the business segment will allow SUPERVALU to concentrate more on its core segments that are profitable. Further, it will help the company get rid of the business, which has not been performing up to the level recently.

Likewise, Procter & Gamble had announced portfolio strengthening and simplification plans in Aug 2014 to streamline its business and focus more on Billion Dollar Brands like Tide, Pampers and Oral-B. After the close of the beauty brands merger with Coty, Inc. COTY in Oct 2016, P&G’s portfolio comprises about 65 consumer and shopper preferred leading brands focusing on 10 categories organized under four industry-based sectors. These brands have historically grown faster and have been more profitable than others.

In the past too, Kimberly-Clark Corp. (KMB Quick QuoteKMB - Free Report) spun off its health care business (in Oct 2014), which is now called Halyard Health, Inc. HYH. Snacking giant Mondelez International also spun off its coffee business to Netherlands-based coffee company, D.E Master Blenders 1753 in Jul 2015 in order to concentrate on its core snacks business. Similarly, in Nov 2015, General Mills divested its Green Giant and Le Sueur brands of frozen and shelf-stable vegetables to food manufacturer, B&G Foods.

Cost Cutting and Restructuring Initiatives

Most consumer staples companies are implementing cost-reduction initiatives to boost profits. Companies like McCormick, Coca-Cola, Molson Coors, Mondelez International, Inc. MDLZ, Kimberly-Clark, Kellogg Co. K, Sysco Corp. SYY, and many others have been benefiting from significant cost savings and restructuring initiatives to boost earnings.

Bottom Line

Given the efforts undertaken by the companies, it is needless to say that investors can cash in on the existing opportunities in the space. How about investing in this space right now?

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

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