| Consumer Staples |
Most consumers can live without the
latest iPod from Apple (Nasdaq: AAPL) or a brand new 46-inch high-definition
television. Such products are known as discretionary purchases -- consumers will
decide to buy or not buy these products based on a variety of factors including
income, expectations for future income growth, and willingness to take on debt.
But while you might think twice before shelling out $2,500 on a new television,
it's unlikely you gave much thought to your last purchase of a $1.00 pack of
chewing gum, $0.50 soda, or $7.00 tub of laundry detergent. In fact, if you're
like most consumers, then you'll continue chewing gum and doing your laundry
regardless of the general condition of the U.S. economy.
Companies that make or sell these everyday necessities are called "consumer
staples" firms. Typically, the consumer staples industry includes
traditional food and beverage companies as well as grocery retailers, fast-food
chains, and drugstores. Companies in these industries are exposed to different
competitive forces; they're by no means fundamentally identical. However, all of
these industries share one common trait -- stable demand for their products.
| Major Players in the Industry |
| Diageo (DEO) |
| Anheuser-Busch (BUD) |
| Altria Group (MO) |
| Procter & Gamble (PG) |
That stability of demand is behind the
consumer staples industry's reputation as a safe group. And there's a great deal
of truth to the sector's reputation for stability; during bear markets and
periods of poor economic growth, consumer staples tend to handily outperform
most other industry groups.
The most recent bear market in stocks lasted from mid-March of 2000 through
early October of 2002. As the chart shows, the S&P 500 Consumer Staples
Sector handily outperformed the broader S&P 500 Index over this period.
Of course, while demand for basic products tends to be stable and
recession-proof, these products don't typically see rapid growth in demand. In
the U.S., for example, demand for food and beverages grows at around 1-3%
annually.
But don't be tempted to simply generalize consumer staples as a slow-growing,
defensive group to hide in when the market is going down. While there are
certainly companies that fit the bill, there are also a handful of standouts
with a track record of growing faster than their industry, developing innovative
high-growth products, and expanding into new markets.
And don't assume steady growth means boring returns for investors. Consider the
case of British alcoholic beverages maker Diageo (NYSE: DEO). While most
investors were licking their wounds during the 2000 to 2002 bear market, Diageo
returned more than +70%. Even more amazing, the stock has continued to
outperform since the 2002 market low -- Diageo is up more than +95% since
October 2002 compared to just +57% for the S&P 500.
To differentiate the top performing consumer staples stocks from the also-rans,
here are three of the most important factors to consider:
Branding/Pricing Power
Just think about your last trip to a grocery store -- you probably noticed
several different types of colas, including both well-known brands like
Coca-Cola (NYSE: KO) and generic brands produced by supermarket chains or other
private label distributors. Even though the generic brands are significantly
cheaper than the branded names, most consumers still buy Coke and Pepsi (NYSE:
PEP) and are more than willing to pay the premium price.
That, in a nutshell, demonstrates the power of branding. Consumers are intensely
loyal to their favorite brands and the best brands have the power to raise
prices and earn superior profit margins even in weak economic times. Just about
anyone can make cola, chewing gum, or even gin. But there is only one Coke,
Wrigley's, and Tanqueray -- while many consumer staples are
basically homogenous products, it's the brand that confers the competitive
advantage.
And strong brands also confer other advantages than simply superior pricing
power. For example, companies can leverage an existing brand to introduce new
products -- Vanilla Coke, Tanqueray No. Ten gin and Microwavable Bounty towels
are all examples of successful brand extensions that gave new products instant
name recognition.
International Growth
While growth in demand for many basic consumer staples is slow in mature
economies, developing markets are a different story. Consider, for example, that
the average American chews about 180 sticks of gum annually. Meanwhile, the
average Chinese consumer enjoys only 15-20 sticks. Similar patterns are evident
in all sorts of consumer staples products, from alcohol to detergent to Taco
Bell (NYSE: YUM) burritos.
As developing economies become wealthier, consumption of basic staples
accelerates rapidly. Eventually, consumption of these basic products is likely
to approach the same levels as in the developed world. This implies growth rates
in the developing world that are far larger than in the U.S. or Europe.
Companies with the scale and scope to expand into rapidly developing emerging
markets will see strong growth for years to come.
Raw Materials Costs
Raw materials costs have been a key factor for some consumer staples products
firms recently. For example, cereal is made from corn, and corn prices have
skyrocketed lately. The same is true of wheat and other basic bulk commodities.
That raises the cost of making cereal. If producers can't raise prices enough to
cover rising costs, then profit margins get squeezed.
To keep on top of these trends, keep an eye on a company's operating profit
margins -- operating income divided by total sales. If operating profit margins
start shrinking, then this can be a sign of rising costs eating into
profitability.
With these points in mind, we'll take a closer look at two consumer staples
firms that enjoy recession-resistant demand for their products and have the
potential for superior growth.
