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Industry Outlook

Will Consumer Staple Stocks Survive Amid Global Worries?

The operating performance of consumer staple companies has been disappointing lately. Last earnings season was quite weak, marked by earnings declines, sluggish growth rates and weak revenues. Unfortunately, the picture is unlikely to improve in the third quarter.

That said, the sector’s real and perceived defensive attributes continue offset these questions about its earnings power, helping Consumer Staples stocks outperform other sectors in the current uncertain and volatile environment. Challenges to the sector’s earnings power appear fairly entrenched, but so are the space’s defensive qualities.  

Macro Challenges

The growing concern over the health of the Chinese economy continues to unnerve investors and the spillover effect is clearly visible across borders, be it in the Asian, European or the U.S. markets. The world’s second-largest economy took the financial markets and global economy by surprise when it unexpectedly devalued its tightly controlled currency, the yuan, in August, signaling that the economic situation was even worse than originally perceived.

Largely as a result of the China uncertainty, the U.S. Fed held off on the long-anticipated lift-off at the September meeting and the decision has likely been pushed back further following the recent soft economic readings like the September non-farm payroll report and the two ISM surveys. The improved odds of a delayed Fed action has spread cheers in the market, with sentiment particularly improving for the emerging markets that remain at risk of losing out from the eventual Fed tightening cycle.

Rising wages and cheaper fuel are positives for the sector. With oil and natural gas prices subsiding, consumers are left with more disposable income. Commodity costs have in many cases stabilized. Consumers are also expecting lower inflation primarily due to lower gas prices. A decline in commodity prices may improve profit margins for certain staples companies.

However, some analysts do not foresee growth accelerating in the months ahead and expect a slowdown in current economic conditions due to weak job numbers. Job figures released by the Labor Department on Oct 2 showed that U.S. employers significantly scaled back hiring in September and added fewer jobs than previously forecast in July and August. Employers created only 142,000 jobs in September. Adding to the gloom, the Labor Department revised August’s employment numbers, registering only 136,000 new jobs for the month, well below the 173,000 originally reported.

In addition to these global worries, continued appreciation of the U.S. dollar relative to most foreign currencies will continue to be a near-term headwind to the earnings of U.S.-based staples companies with significant international operations. Other risks include potential price wars, a competitive environment, slowdown in international markets (including continued slowdown in China), political turmoil in Russia, sluggishness in Japan and an unfavorable economic environment in Europe.

How Will the Players Fare This Earnings Season?

Among the consumer staple stocks that have already reported their quarterly results so far include McCormick & Co., Inc. (MKC - Analyst Report), General Mills, Inc. (GIS - Analyst Report) and ConAgra Foods, Inc. (CAG).

General Mills reported first quarter fiscal 2016 results (ending Aug 30) on Sep 22, wherein its earnings surpassed the Zacks Consensus Estimate but marginally missed on sales. Easy year-ago comparisons and aggressive cost cuts from the packaged food company’s restructuring initiatives led to profit growth amid changing consumer preference and an unfavorable currency environment.

McCormick delivered mixed results in the third quarter of fiscal 2015 (ending Aug 31) on Oct 1. While earnings lagged the Zacks Consensus Estimate, revenues exceeded the consensus mark, due to strong sales momentum. Moreover, the company raised its constant currency sales growth rate guidance and expects fiscal 2015 adjusted earnings per share to be at the lower end of the company's previously guided range.

Premier North American food company ConAgra Foods also reported mixed results for first-quarter fiscal 2016 (ended Aug 30, 2015) on Sep 22, wherein earnings beat the Zacks Consensus Estimate but revenues missed. We believe the negative impact of the strengthening U.S. dollar has partially offset the benefits reaped from improving business in the company’s Commercial Foods and Consumer Foods segments as well as lower operating expenses.

Now let us look into other Consumer Staples stocks that have the potential to beat estimates this earnings season, despite global worries. There are quite a few companies in the consumer staples space. To find out companies that are likely to beat expectations in their upcoming releases, we will narrow down the list of choices by looking at stocks with a favorable Zacks Rank of #1 (Strong Buy), #2 (Buy) or #3 (Hold) – and a positive Earnings ESP.

After screening, we have zeroed in on just a few industry players like Coca-Cola Enterprises, Inc. (CCE - Analyst Report), Cott Corporation (COT - Snapshot Report), Dean Foods Co. (DF - Analyst Report), Flower Foods, Inc. (FLO - Snapshot Report), The Kraft Heinz Company (KHC - Snapshot Report), Lancaster Colony Corporation (LANC - Snapshot Report), Mondelez International, Inc. (MDLZ - Analyst Report), Newell Rubbermaid Inc. (NWL - Analyst Report), The New York Times Company (NYT - Analyst Report), and Ollie's Bargain Outlet Holdings, Inc. (OLLI - Snapshot Report). All these stocks have a positive ESP and a favorable Zacks Rank, required to beat expectations.

We can therefore sense that limited consumer spending due to macro-economic headwinds will remain a concern for consumer staple companies. The current state of the economy, uncertainty over the Fed rate hike and China concerns are expected to weigh on third quarter results and will remain a concern through the rest of the year.

Zacks Industry Rank

Consumer Staples is one the 16 broad Zacks sectors within the Zacks Industry classification. We rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The Consumer Staples sector is further sub-divided into the following industries at the expanded level (260 industry groups): Agricultural Operations, Beverages – Alcohol, Beverages – Soft, Consumer Products – Miscellaneous Staples, Cosmetics & Toiletries, Food – Miscellaneous/Diversified, Publishing – Newspapers, Soaps & Cleaning Preparations, Textile – Apparel and Tobacco.

Only one of the sub-sectors is placed in the top 1/3rd of the 260+ industry groups, and that is Textile – Apparel, holding a Zacks Industry Rank #67. Others fall in the middle portion of that group, with Agricultural Operations holding a Zacks Industry Rank #113. It is followed by Food – Miscellaneous/Diversified; Consumer Products – Miscellaneous Staples and Tobacco, holding ranks of #159, #163 and #170, respectively.

The remaining sub-sectors are featured in the bottom one-third. Publishing – Newspapers holds a Zacks Industry Rank #177. Beverages – Soft is standing at #194, while Beverages – Alcohol is at the #206 spot. Cosmetics & Toiletries and Soaps & Cleaning Preparations hold a Zacks Industry Rank of #198 and #212, respectively.

Looking at the exact position of these industries, one could say that the general outlook for the consumer staples space is negative. This signals that the economic picture is quite weak, despite a modest recovery in economic environment.

Earnings Trends

The majority of Consumer Staples companies have yet to report their third quarter results. On a year-over-year basis, total earnings for this sector are expected to decline 4.5% in the third quarter compared with a decline of 0.3% registered in the second quarter of 2015. Total revenue is expected to decline 0.4% in the third quarter compared with a decline of 6.7% in the previous quarter.

The sector is expected to contribute 6.5% of the total S&P 500 income for 2015, less than its 8% market cap weight in the index at present.

Bottom Line

The first half of 2015 turned out to be a mixed bag for consumer staples stocks. While on the one hand, the stocks were benefited by a gradual economic recovery and increase in consumer spending power owing to lower fuel prices and higher wages; on the other hand, concerns over China and significant foreign currency headwinds weighed on these stocks. But overall, the current trend is not positive due to above mentioned issues, which are expected to pressurize global markets at least til 2016.

For more details about earnings for this sector and others, please read our ‘Earnings Trends’ report.

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