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Will an Improving Economy Benefit Consumer Staples Stocks?

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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 on a recovery mode.
Consumer confidence – a key determinant of the economy’s health – had increased sharply in February and March. However, it declined in April due to less optimism in the labor market. Despite the decline, we expect consumers to remain confident regarding the economy in the near term. This positive sentiment is hence likely to translate into higher consumer spending, which accounts for more than two-thirds of U.S. economic growth.
While estimates for GDP growth increased marginally by 0.7% in the first quarter 2017, overall growth for the year is expected to improve from last year. GDP is expected to increase 2.3% in 2017 compared with 1.9% last year. The recent improvement in financial conditions is expected to contribute to the upside.
This modestly above-trend pace will further tighten the labor market, with the unemployment rate expected to decline to 4.3% by the end of this year and to 4.1% by mid-2018. That will help bump up inflation to 2% or higher over the next two years.
However, currency fluctuations and other global headwinds might dent the performance of the companies in the consumer staples space. Given such headwinds, the staples sector seems to be quite a reliable and attractive area to invest in, as these stocks can lend stability to an equity portfolio due to the relatively consistent nature of consumer demand for the products.
The sector may also appeal to income-oriented investors because of relatively attractive dividend yield than the yields offered by many bonds. Many consumer staples stocks have successfully increased their dividends over time. Therefore, despite the disruptive forces, the consumer staples sector should continue to benefit riding on steady growth, dividend income, and low volatility.
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.

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 - Free Report) and cereal maker General Mills Inc. GIS. 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 - Free Report) 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 from packaged food items to healthier and nutritious products in view of increasing health consciousness, rising obesity concerns and growing regulatory pressure. Companies that can respond effectively to this healthy food movement appear to be well poised in 2017 or otherwise it may hamper their sales growth. For example, food manufacturer Kellogg Company (K) posted sales miss in its recently reported first quarter of 2017 on industry-wide soft consumption trends for packaged food items.
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 - Free Report) have been benefiting from strong demand for natural/organic food products and expect the trend to continue.
Food company, Pinnacle Foods Inc.’s PF acquisition of Boulder Brands, Inc. in Jan 2016 helped the company 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 - Free Report) , is also reshuffling its portfolio to increase the amount of organic herbs and spices amid the rising demand for organic food products.
America’s largest soft drinks makers -- The Coca-Cola Company (KO - Free Report) , PepsiCo, Inc. (PEP - Free Report) 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.
Food and beverage companies are not the only ones trying to shift to healthier options. Tobacco companies like Altria Group Inc. (MO - Free Report) , Reynolds American Inc. RAI are also adapting to the evolving needs of consumers and have resorted to less harmful alternatives like electronic cigarettes (e-cigarettes).
To cater to changing consumer preference, Philip Morris International, Inc. (PM - Free Report) launched the much talked about IQOS, a smokeless cigarette in Nov 2014, aiming to lead the tobacco industry’s push into reduced-risk products that may eventually replace traditional smokes. IQOS is anticipated to boost market share and offset declining volumes in traditional cigarette business in 2017.
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.
Mergers of Tyson Foods with packaged meat producer, The Hillshire Brands Company (in Aug 2014); tobacco giants Reynolds American and Lorillard (in Jun 2015); and food giants - Kraft Foods Group, Inc. and H.J. Heinz Company (in July 2015) were the most talked about deals of the past.
Belgium-based brewer Anheuser Busch InBev’s BUD acquisition of London-based rival, SABMiller plc in Oct 2016 also created a buzz in the beverage industry. Molson Coors acquired SABMiller plc’s 58% stake in MillerCoors, which was a joint venture of Molson Coors and SABMiller (formed in 2008). The deal made 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.
The entity formed, The Kraft Heinz Company KHC, after Kraft Foods Group, Inc. and H.J. Heinz Company merger is now the fifth-largest food and beverage company in the world. Recently, it has made an unsolicited $143 billion takeover offer to Unilever Plc (UL - Free Report) but the deal failed.
Other smaller companies have also grown through acquisitions in the space. Treehouse Foods Inc. (THS - Free Report) , 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.
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).
We are now looking forward to the highly anticipated tobacco merger between Reynolds American and British American Tobacco Plc BTI, which is expected to close in the third quarter of 2017 and is still subject to satisfaction or waiver of the other closing conditions specified in the merger agreement.
The companies are also focusing on improving their product portfolio through divestitures, which enables them to concentrate on their core portfolio. For example, Unilever has decided to sell its shrinking spreads business, including brands like Flora and Stork butter, which has been witnessing a slowdown for the past few quarters. Unilever also stated that it is integrating its food and refreshment businesses into a Netherlands-based unit.
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, in 2016, Iconix Brand sold the rights for the Sharper Image brand and related intellectual property assets to ThreeSixty Group, while sold the rights for Badgley Mischka IP to Titan Industries, Inc. The company, at present, is also planning a sale of its majority stake in Peanuts Worldwide LLC, which owns the rights to cartoon strip characters Snoopy and Charlie Brown. Besides Peanuts, Iconix is also looking to sell its Strawberry Shortcake brand, which is based on a character that rose to fame in the 1980s as a doll for young girls.
On Dec 6, SUPERVALU Inc. SVU completed the divestment of its Save-A-Lot business to private equity firm Onex for $1.365 billion in cash. The sale of the business segment will allow SUPERVALU to concentrate more on its core segments that are profitable.
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.
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 - Free Report) , Kimberly-Clark Corp. KMB, Kellogg Co. K, Sysco Corp. (SYY - Free Report) , and many others have been benefiting from significant cost savings and restructuring initiatives to boost earnings.