Consumer staples stocks are oft known as ‘defensive’ investments, popular in times of stock market uncertainty. Historically, these companies, which produce or sell products that are always in demand, have served investors well, with growing, secure and reliable dividends.
But in the past 12-18 months, that defensive status has come under threat. “Consumer staples companies have been one of the great disasters of this year,” claims Simon Edelsten, manager of Morningstar Silver Rated Mid Wynd International (MWY).
Over the year to 5 October, the S&P 500 Consumer Staples sector has returned just under 2%, compared to the wider market’s 16.5%, according to Morningstar Direct data.
Looking more globally, the MSCI All Countries World Index Consumer Staples sector has lost almost 1% compared to the MSCI ACWI’s gain of 7.8%. Closer to home, the FTSE All-Share Consumer Goods sector has lost 6.7%, as opposed to the FTSE All-Share’s 3.5% gain.
None of this screams safe. And yet, many of the S&P 500’s worst performers in the staples sector in the year-to-date – Kraft Heinz (KHC), General Mills (GIS), Philip Morris (PM), Colgate (CL) – that are down 15%-plus still look expensive, trading on 20-30 times earnings.
Earnings growth has stalled in recent years, which means dividend growth has, too. A favourite statistic Stuart Rhodes, manager of the Morningstar Silver Rated M&G Global Dividend fund, likes to share with clients is dividend growth since 2009 for five companies including Procter & Gamble (PG), Kelloggs (K) and Walmart (WMT).
This trio saw annualised growth of 8-13% in their payouts between 2009-11. That fell to 5-10% between 2012 and 2014, but the market still rewarded the stocks. In the past two years, that growth has fallen significantly to no more than 3%.
Headwinds for Bond Proxies
“What started to happen in 2011/12 was the algorithm of low-single digit sales growth and a little leverage through the profit/loss account to give you that earnings and dividend growth started to crack,” explains Rhodes.
“Now, 2015-17, you’ve seen a complete collapse of the companies’ ability to grow the dividend. This is simply because they can’t afford to pay more. That is a problem and means you’re not worth 25 times earnings.”
As a result, the fund’s exposure to staples firms has fallen from a quarter of assets six or seven years ago to less than 10% today.
So, what has happened to the earnings of these companies? The problem, according to Edelsten, is that they haven’t had any growth in the developed world for a long time. Emerging markets has been where their growth has come from in recent years, and that is now under threat.
“They only get growth out of their earnings in Turkey, Venezuela and other places like that. And when the currency goes down, you have no growth,” he adds.
Again, Edelsten says he started gradually selling out of these expensive stocks, the likes of Nestle, which went three years ago, then L’Oreal (OR) and Colgate. “The defensive tag is false comfort for fund managers. If you’re in an expensive stock that’s not growing, you’re going to lose money.”
Another headwind for consumer staples firms has been the rising interest rate environment we’ve seen ever since the Fed started hiking in 2015.
Stephen Anness and Andrew Hall, co-managers of the Invesco Global Opportunities fund, says: “Shares in this sector have been highly correlated to bond yields since the global financial crisis. Thus, the sharp increase in the US 10-year yield in the past 18 months has helped cause the sector to underperform.”
Other worries the pair have over the sector are elevated levels of competition from innovative new entrants, which has impacted both volume growth and pricing power; and significant leverage that companies have taken on in order to make acquisitions.
“While valuations have retreated, the sector still trades at a multiple that is only a little below long-run averages,” they continue.
But some fund managers continue to find value in selective parts of the market. Matthew Page says his Guinness Global Equity Income fund has upped its exposure to staples over the past 18 months.
“The sector has been hit reasonably hard and we just think valuations there are getting a bit more compelling, particularly in the context of the broader uncertainty that markets are experiencing at the moment.”
The fund added Walmart in January 2017 and that is up around 50% since. More recently, Nestle (NESN) has come in this year.
Job Curtis, manager of the Morningstar Gold Rated City of London Investment Trust (CTY), has 13.6% of his trust’s assets in staples, including Diageo (DGE), Britvic (BVIC) and Reckitt Benckiser (RB.). He’s added Coca-Cola (KO) to that list, too.
An attraction of the famous drinks firm, which recently bought the Costa Coffee chain from Whitbread (WTB), is a 3.4% dividend yield that has grown by 8% per annum over the past 10 years. Meanwhile, they have disposed of a lot of their capital-intensive bottling plants and have grown their non-fizzy drinks business to almost a third of revenue.
“It’s a great company with iconic brands and a big presence in emerging markets,” Curtis adds.
Tobacco Stocks Look Cheap
Many fund managers are in agreement about the opportunity set presented by tobacco firms. That’s despite a claim from Henna Hemnani, assistant manager on Miton’s multi-asset fund range, that “it seems only logical to avoid tobacco companies that are struggling to replace the demand for their traditional product with substitute vaping products”.
Some of the largest tobacco companies around the world have under-performed in the past year. In fact, in the year-to-date British American Tobacco (BATS), Imperial Brands (IMB), Philip Morris and Japan Tobacco (2914) are all down between 12-30%.
Despite a challenging environment, Page notes that the tobacco industry has always been a market in volume decline. “Yet in certain periods it performs extremely well,” he adds.
They have been “a real core holding” for Curtis, with BATS and Imperial accounting for 5% of the portfolio. “You can’t ignore the disruption risk, but they’re on pretty attractive valuations and the dual products seem to be enticing new users to nicotine as much as cannibalising existing smokers.”
Valuations are around 9-12 times next year’s earnings now and Page has increased his exposure to the sector, buying BATS late last year. He also holds Imperial and Japan Tobacco.
Rhodes, meanwhile, holds Imperial, which “is exceptionally cheap” with a net yield of 7% rising to almost 8% next year.
