By Jacob Sonenshine
Consumer staples are on the verge of a breakthrough.
They've pushed back on a downturn of the broader market and now are within a stone's throw of rising above a key level.
The Vanguard Consumer Staples exchange-traded fund, for example, has drop only 0.9% since March 28, when the S&P 500 began an almost 3% slide.
And in the second half of April, staples ticked higher. The climb suggests investors see the economy slowing down, as interest rates remain higher for longer. Names like Procter & Gamble chalk up consistent profits even when shoppers spend less because of what they sell: low-cost essentials.
Still, while the stocks have outperformed, they haven't had blistering increases. As John Kolovos, chief macro strategist at Macro Risk Advisors, writes: The "staples sector [is] improving on a relative basis."
Today, the fund trades at $202, just below its record closing high of about $204. It has landed where it is because of a fairly steady climb -- what investment doesn't have stops and starts? -- over the past few decades.
Breaking above $204 would be key since the fund has come within striking distance several times over the past couple of years. It would be a clear sign that buyers see more reason to jump in. And, consequently, the price would probably go higher and stay there.
That reason is becoming clearer. The economy is indeed slowing down, threatening to reduce the market's expectations for earnings growth for many sectors.
But companies in the staples fund should increase aggregate sales by 2.6% annually through 2026 if analysts' expectations are accurate, according to FactSet. With the cost of goods and raw materials holding fairly steady, profit margins can rise. In turn, companies can buy back stock, and per-share earnings can grow at just over 7% a year.
Plus, dividends should grow as staples companies generate more cash. If aggregate dividends grow at their recent clip over the next 10 years, the average annual payment would yield 3.4%. That would pad total return -- stock-price gains plus dividend yield -- as long as they're not overvalued.
And they're probably not. The fund trades at 20.3 times expected earnings for the coming 12 months, only a hair over the S&P 500's 19.8 times. That's a tiny premium, given that staples can trade at a double-digit percentage premium over the broader index when investors are more interested in the sector.
So what we looked for are staples that have expected growth in both earnings and dividends, and trade at lower valuation premiums to the market than they potentially could.
Kroger, Philip Morris, Procter & Gamble, and Colgate-Palmolive fit the description.
Coca-Cola checks all the boxes, too. It trades at 21.5 times earnings, but can historically trade at nearly a 40% premium.
Plus, the business is doing just fine. Sales in the first quarter grew 11% year over year, excluding the downside of a stronger dollar. The company raised prices without scaring off customers -- volumes rose 1%. Management has invested in new categories -- zero-sugar, energy drinks and smaller containers -- and flexed its pricing-power muscle. In the quarter, cost of goods decreased, sending margins higher. Analysts expect earnings and dividends to grow over the next several years.
The company has "great predicability of earnings, they keep growing by innovating, they keep moving into growing categories like energy drinks, " says Markus Hansen, portfolio manager at Vontobel Asset Management, which owns the stock.
Hershey trades at 20.5 times earnings, but can sometimes trade at a double-digit premium to the market.
Sales in the first quarter grew almost 9%, driven by higher prices and higher volumes, with the fastest growth in North America. While cocoa costs increased and reduced gross margins, the market was already aware of the problem. Gross margin came in above forecasts. Revenue beat estimates by a higher percentage than commodity costs. Analysts expect margins to stabilize within the next couple of years on the back of strong pricing and calmer cocoa prices.
"Hershey remains a top focus name among investors," writes Evercore analyst David Palmer, citing general strong demand, especially at home versus private competitor, Mars.
Now, these are points to really chew on.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 06, 2024 13:26 ET (17:26 GMT)
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