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Industry Outlook

The recent disappointing jobs report has raised legitimate questions about the U.S. economic outlook. These questions notwithstanding, the best one can say about the U.S. economic outlook is that it can continue to muddle-through at the growth pace of the last few years going forward as well. That isn’t the case with the rest of the world, with the outlook for emerging markets, particularly China, notably uncertain.

The Chinese economy has been struggling and its stock market saw a terrible sell-off last year. The slowdown in China is lowering international revenues for U.S. companies.

Currency headwinds, uncertainty regarding the Fed rate hike, potential price wars, a competitive environment, slowdown in international markets, political turmoil in Russia, sluggishness in Japan and an unfavorable economic environment in Europe are some of the other headwinds for these operators.

The best one could say about the outlook for consumer staples stocks at present is that the sector’s perceived defensiveness should help them in the current uncertain environment. That said, the operating environment is far from friendly.

WEAKNESSES

Slowdown in Emerging Markets

The majority of the global population lives in emerging economies. Due to a slowdown in income and consumption growth, affordability is low. Though there remains huge opportunity for sales growth in these markets, currently the state of affairs remains volatile. Besides China, which is struggling since the past few quarters, developing countries like Brazil and Mexico are facing economic slowdowns. The Middle East, Russia and Ukraine are witnessing continued political and civil unrest resulting in challenging operating conditions. Some developed markets are also facing weakness due to sluggish consumer demand.

For example, consumer product company Unilever plc (UL - Free Report) witnessed some improvement in India and more stable conditions in China in 2015, but is still struggling with declining volumes in Brazil and a soft economy in Russia. The company is also witnessing weakness in the developed markets with little sign of recovery in North America or Europe. Moreover, it still remains cautious as consumer demand continues to be weak.

Beverage giant, The Coca-Cola Company (KO - Free Report) also remains apprehensive of broader economic challenges in the future quarters. While the macro-environment is improving in North America, Japan and India, Coca-Cola expects challenges in many key emerging/developing markets like Brazil, Russia and China.

Companies like Procter & Gamble Co. (PG - Free Report) and Kellogg Co. K are also struggling with decelerating growth in the developing markets and currency headwinds. U.K.-based brewer Diageo Plc DEO also faces macroeconomic headwinds and tough retail conditions in emerging markets.

Higher Operating Expenses to Limit Profits

Consumer staple companies tend to spend heavily on marketing and advertising. Though advertising strengthens brand appeal and helps to counter competition, it severely hits the profit margins of these companies. Companies like Kimberly-Clark Corp. (KMB - Free Report) , PepsiCo Inc. (PEP - Free Report) and Procter & Gamble have significantly stepped up their investments in marketing, innovation, R&D, supply chain and capacity additions which will put pressure on profits. Pinnacle Foods, Inc. (PF - Free Report) incurs higher expenses as a result of innovation and promotional activity.

Increased Competition

Some of the consumer staples companies are impacted by accelerating competition due to the growth of low-cost, emerging-market production. This is resulting in shrinkage of pricing power and decline in market share, which is in turn compressing margins and squeezing earnings.

For example, Kimberly-Clark’s diaper segment is witnessing lower market share and higher competitive promotional activity, as its Huggies diapers are competing with Procter & Gamble’s cheaper Luvs and upscale Pampers offerings. The J.M. Smucker Co.’s (SJM - Free Report) mainstream Pet Food business is also facing heightened competitive activity and challenges in dry dog food against a deflationary macro environment, which is impacting the performance of its Kibbles 'n Bits brand.

Unfavorable Foreign Currency Impact

Companies, which have a significant presence in the emerging markets, are being affected by currency headwinds, given the weakening of many emerging market currencies against the U.S. dollar.

Foreign exchange is a major headwind for companies like Estee Lauder Companies, Inc. EL, Mondelez International, Inc. (MDLZ - Free Report) , General Mills, Inc.GIS, Kimberly-Clark, Unilever and PepsiCo, which have significant business outside the U.S. Venezuelan currency issues are also hurting Nu Skin Enterprises, Inc.’s (NUS - Free Report) earnings significantly.

Though currency pressure will ease in the second half of 2016 due to the recent weakening of the U.S. dollar compared to the prior year, its impact would still hurt profits.

Declining Volumes

Many consumer staples companies are struggling with declining volume or soft volume growth, which is hurting their top line.

For example, tobacco companies like Altria Group, Inc. (MO - Free Report) , Philip Morris International, Inc. (PM - Free Report) and Reynolds American, Inc. (RAI - Free Report) are facing declining shipment volumes mainly due to higher prices of cigarettes. The government has imposed higher excise taxes on cigarettes, as a result of which tobacco companies are increasing their cigarette prices. Higher prices of cigarettes are leading to lower cigarette volumes. Further, rising competition from fake versions of branded cigarettes by local retailers is also hurting cigarette volumes.

Volumes of food company Mondelez International have been hurt by the elasticity impact from higher pricing and category weakness because of soft consumer demand.

Beverage companies like Dr. Pepper Snapple Group Inc. DPS, Coca-Cola and PepsiCo (PEP - Free Report) have also been seeing declining volume trends in their carbonated soft drinks businesses due to category weakness. Muted volume trend will remain a concern going forward.

Bottom Line

As is evident, there are plenty of concerns in the consumer staples industry. However, as regards investing in the space right now, are there any opportunities for short-term investors?

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

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