Consumer Staples

I had lunch yesterday on eastern Long Island with my friend Richard, who is an astute investor despite being handicapped by being a physician.  Among other things, we talked about Consumer Staples.  He’s a big fan.  …me, not so much.  Anyway, I decided to write about this sector today.

starting with the nuts and bolts:

–the S&P 500 Consumer Staples sector makes up 10.3% of the total capitalization of the S&P 500 index.  That puts it about in the middle as far as size goes.  (IT, at an 18.1% weighting, is the biggest sector;  Telecom, at 2.5%, is the smallest.)

–the Consumer Staples sector has 40 constituents.  Procter and Gamble, Coca-Cola and Philip Morris are the biggest three.  Of them, only P&G cracks the top ten for the S&P as a whole.

–as the sector name suggests, members provide everyday necessities, like groceries, whose purchase isn’t easy to postpone.  It contrasts with Consumer Discretionary, which deals in items like entertainment or restaurant meals, that people can go without for a while.

steady growth → defensive industry

True, every sector has some sensitivity to economic conditions, even Utilities and Staples.  But in these two cases, the sensitivity is small.

In bad times, people may buy one bar of soap instead of a three-pack, or a store brand rather than a deluxe offering.  But they continue to buy something.  That’s not the case with big-ticket items, like refrigerators, autos, houses, industrial machinery, hotels…

As a result, earnings for Staples companies hold up better than for most other sectors in recession.   Knowing this, investors flock to the sector in bad times–and away from it toward more cyclically-sensitive areas when recovery is underway.

a global, but mature, industry…

…except for in emerging markets.  Staples companies tend to grow by taking market share away from their rivals, rather than by finding new customers who have, say, never used shampoo before.  Yes, these firms can raise prices under most conditions (not so much currently) but generally by no more than overall inflation.  So eye-popping profit growth is rare.

sensitive to currency and to input costs

That’s because they can’t raise prices quickly.

a play on the €?

The sector tends to have large EU exposure.

And that’s a potential reason to be interested in the sector today.  If the € beings to rise against the $, which I think is likely, EU-oriented Staples companies should start to show surprisingly strong earnings gains.  That will come both from better unit volume growth as the EU recovers from recession and–more importantly–from the higher value in $ of their € profits.

I haven’t acted on this though yet.  But I’m considering it.