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Consumer Staples Stock Outlook - January 2017

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Will Consumer Staples Sector Bounce Back from the Dip?

Consumer Staples stocks are traditionally known to be defensive and are most trusted during periods of economic downturn. In 2016, a number of issues, especially worries in China, unnerved investors. Later, the Brexit storm created a rippling effect and heightened market volatility. The Presidential election and the rate hike uncertainty during September also left investors jittery. In such a scenario, consumer staples companies were a safe haven as these benefited from effective cost-cutting and lower energy input costs.

Though the sector will not completely escape market bumps going forward, it seems that global growth concerns have begun to fade and the political uncertainty caused by the U.S. election is gradually diminishing. Companies are looking forward to the policies of the new government and how those will benefit them. Trump’s tax and spending proposals are expected to aid growth in the near term.

In such a calm and optimistic market, investors might not be enthusiastic to invest in a defensive sector.

Current Market Scenario

Undoubtedly, the economy is in good shape. The recent increase of benchmark interest rates by the Federal Reserve by a quarter-point to a range of 0.50%−0.75% indicates that the U.S. economy is gaining momentum with inflation gradually edging toward the desired 2% target.

Consumer confidence – a key determinant of the economy’s health – also increased considerably in December, after posting considerable gain in November. The labor market is also improving owing to a gradual rise in wages. The improving economy was also supported by the rise in GDP rates for the third quarter.

In fact, the encouraging data are well reflected in the three key U.S. indexes, which have closed in positive territory over the past one year. The Dow Jones Industrial Average (DJI) increased 24.6% to close at 19,799.85. The S&P 500 rose 20.68% to close at 2,265.20, while Nasdaq grew 18.9% to 67.32 over the past one year.

All these factors signal that the economy is beaming with growth and consumer spending is likely to boost ahead. This generally benefits the staples sector as well. However, currently, it seems that with improving U.S. economy and global economic growth, investors might look for other lucrative sectors than consumer staples sector that generally acts as a port in times of storm.

Zacks Industry Rank

The Consumer Staples sector is one of 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. The broader Consumer Staples sector is currently placed at the bottom most of the Zacks Classified sectors (16 out of 16).

As a guideline, the outlook for industries in the top one-third of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle one-third or industries with Zacks Industry Rank between #89 and #176 is 'Neutral', and the bottom one-third 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 Operation, Beverages – Alcohol, Beverages – Soft, Consumer Products – Staples, Cosmetics, Food – Miscellaneous, Food – Meat Products, Food – Dairy Products, Food – Confectionary, Publishing – Newspapers, Publishing – Periodicals, Publishing – Books, Funeral Services, Soaps & Cleaning Materials, Textile – Apparel and Tobacco.

Only one sub-sector is placed in the top one-third of the 260+ industry groups and that is Agricultural Operations with a Zacks Industry Rank #65.
A number of them fall in the middle portion of that group, with Food-Meat Products, Publishing – Periodicals  and Tobacco, each holding the same Zacks Industry Rank #90. It is followed by Food – Miscellaneous, which carries a Zacks Industry Rank #159.

A large chunk of them fall in the bottom portion of the group. While Publishing – Newspapers carries a Zacks Industry Rank #198, both Beverages – Alcohol and Beverages – Soft sub-sectors hold the same Zacks Industry Rank #214. It is followed by Textile – Apparel, holding a Rank #218 and Soaps & Cleaning Materials, which carries a Rank #219. Food – Dairy Products and Food – Confectionary, both carry the same Zacks Industry Rank #224. Cosmetics, Consumer Products – Staples, Publishing – Books, and Funeral Services with Zacks Industry Rank #240, #242, #243 and #247, respectively, come in the bottom one-third.

Looking at the exact position of these industries, one could say that the general outlook for the Consumer Staples space is negative. Though the companies in the consumer staples sector will benefit from cost cutting initiatives and lower energy input costs, increased competition among industries will squeeze margins. Further, the improving economy, further boosted by Trump’s policies, could hurt the defensive sector.

Earnings Trends

The stage is set for the fourth-quarter earnings season with investor anxiety at its peak on how the quarter will unfold amid mixed economic data. As of Jan 20, 12.5% of the total consumer staples S&P 500 members have reported fourth quarter results. Total earnings are up 1.4% from the same period last year, while revenues declined 4.6%. Earnings “beat ratio” is 75.0%, with revenue "beat ratio" of 50.0%.

Few S&P 500 consumer staples stocks that have recently reported their quarterly results include General Mills, Inc. (GIS - Free Report) , which reported second-quarter fiscal 2017 results on Dec 20. The company’s earnings and revenues missed the Zacks Consensus Estimate. Organically, year-over-year sales growth is now anticipated to decline in the range of 3% to 4%, wider than the earlier expectation of flat to down 2% for fiscal 2017. General Mills carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

On the other hand, The Procter & Gamble Company’s (PG - Free Report) second-quarter fiscal 2017 earnings and revenues exceeded expectations. On Jan 20, P&G reported earnings of $1.08, which increased 3.8% from the prior-year quarter on higher margins. Currency-neutral core EPS per share improved 9%. Organically (excluding the impact of acquisitions, divestitures and foreign exchange), revenues grew 2% on the back of a 2% increase in organic volumes. The Cincinnati-based company raised its organic sales growth projection to a range of about 2–3% from 2% projected earlier for fiscal 2017.

McCormick & Company, Inc. (MKC - Free Report) is scheduled to report results on Jan 25, before the bell, while Kimberly-Clark Corporation (KMB - Free Report) is scheduled to report on Jan 24, before the market opens. Both the stocks hold a Zacks Rank #4 (Sell).

Earnings for the fourth quarter for the consumer staples sector are currently expected to be up 9.6% compared with 6.3% growth in the third quarter. Revenues are expected to be up 4.2% in the quarter compared with 0.6% growth reported in the last quarter.

As a whole, total fourth quarter earnings for the S&P 500 companies are expected to be up 4.8% from the same period last year on 3.7% higher revenues. This would follow the 3.8% growth in third quarter earnings on 2.3% higher revenues. This is the first instance of positive earnings growth for the index after five quarters of back-to-back declines. This signals that the improving economy is helping aggregate the growth picture. For more details about earnings for this sector and others, please read our ‘Earnings Trends’ report.

Bottom Line

Consumer behavior has been unpredictable and their willingness to spend vigorously has diminished due to global uncertainties as seen in the first half of 2016. But currently the economy seems robust on the back of growing income and solid employment numbers. The sector is expected to grow with rising consumer spending. Trump’s administration is also expected to boost the U.S. economy.

However, the overall improving economy will shift investors’ focus from the defensive consumer staples sector to more aggressive sectors. Nevertheless, the economy is still not free from headwinds. Hence, the sector can always provide a cushion to risk-averse investors.