Is An Improving Economy Driving Consumer Staples Stocks?

Backed by an improving economy, the consumer staples sector has been performing really well among most product categories over the past few months. Lower gas prices and increasing consumer confidence are doing the trick for a number of operators in this space. Importantly, consumer staples are benefiting from their perceived stability and defensive attributes in the current uncertain global backdrop.

Consumer confidence is now at its highest level since the recession. Consumer confidence index surged for the second consecutive month in September, signaling that the economy is improving. Stepped-up economic activities, improving business conditions, housing market recovery, a buildup in inventories and improving labor market are some favorable economic indicators that play a key role in raising buyers’ confidence.

Though the decline in oil prices caused worries related to global deflation and an economic slowdown, it eased consumer spending power. Notably, consumer spending accounts for more than two-thirds of U.S. economic growth.

A rise in wages has also increased household wealth and eventually boosted consumer spending. A number of retailers and fast food chains, including Wal-Mart Stores (NYSE:WMT), Inc. (WMT), McDonald's Corp (NYSE:MCD). (MCD), Target Corp. (NYSE:TGT) (TGT) and The TJX Companies (NYSE:TJX), Inc. (TJX) have hiked wages.

Performance of Consumer Staples Sector

With respect to the broader economy, GDP growth was fairly weak in the first two quarters of the year, but is expected to come back in a meaningful way in the current period. While areas like manufacturing, exports and capital investments are suffering, many other aspects of the economic picture are showing a lot more strength.

Households are benefiting from steady labor market gains, with even wages starting to show momentum lately. The housing industry is another bright spot, promising steady momentum going forward. Many analysts see the U.S. economic outlook as stable and improving; better than most other parts of the world.

Market experts believe that consumer staples stocks have the potential to counter macro headwinds like the Brexit aftershocks, the Federal Reserve’s possible rate hike in December, impact of currency fluctuations and other global growth issues.

Companies in this space typically have tight margins, and a reduction in energy prices over the last two years is helping them to reduce costs. Going forward, consumer staples companies will continue to benefit from decreasing commodity and lower energy costs, which will aid profit margins.

Apart from this, let’s discuss some of the key factors that have been driving consumer staples stocks in the past few quarters, despite global worries, and also have the potential to boost earnings in the near term.

OPPORTUNITIES

Innovations

In a crowded and competitive space, consumer product companies need to regularly innovate and upgrade their brands to create differentiated value propositions and to remain successful. In fact, companies with innovative products in their pipeline will be in a position to benefit.

Innovation has been a driving force for consumer product giants like The Procter & Gamble Co. (PG) and cereal maker General Mills Inc (NYSE:GIS). (GIS). P&G believes that consistent product innovation, supported by strong marketing and commercialization, will help deliver stronger results over the long term.

Global brewer Molson Coors Brewing Co. (TAP) has also been launching new products to boost revenues and market share, which help it to offset the impact of declining volumes. Molson Coors also invests in marketing and advertising to create brand awareness.

Transition to Health and Wellness and ‘Good-for-You’ Products

Consumer staples companies are also shifting focus to make healthier and nutritious products in view of increasing health consciousness, rising obesity concerns and growing regulatory pressure.

Food companies, B&G Foods, Inc. (BGS) and General Mills have been rolling out a variety of nutritious products. Natural and organic food/beverages maker, The WhiteWave Foods Company (WWAV), J&J Snack Foods Corp. (JJSF) and United Natural Foods, Inc. (UNFI) have been benefiting from strong demand for natural/organic food products, and expect the trend to continue.

Pinnacle Foods Inc. (PF) acquired Boulder Brands, Inc. in Jan 2016 in order to meet changing consumer tastes, which lean toward healthier offerings. The company also aims to expand its presence in the natural and organic retail channel.

The global leader in spices and seasonings, McCormick (NYSE:MKC) & Co., Inc. (MKC), is also reshuffling its portfolio to increase the amount of organic herbs and spices amid the rising demand for organic food products. It now plans to ramp up its organic and non-GMO offerings by 2016.

America’s largest soft drinks makers - The Coca-Cola Company (NYSE:KO) (KO), PepsiCo (NYSE:PEP), Inc. (PEP) and Dr Pepper Snapple Group (NYSE:DPS), Inc. (DPS) are also shifting toward healthier and nutritious products. Accordingly, the companies agreed to promote bottled water, no-or-lower-calorie beverages and smaller portion sizes to its consumers.

Coca-Cola is growing its portfolio through acquisitions and investment in the non-alcoholic beverage industry. Pepsi is also working to expand the range of its nutritious product offering with health benefits like reduced calorie beverages, non-carbonated beverages as well as healthier snacks.

Food and beverage companies are not the only ones trying to shift to healthier options. Tobacco companies like Altria Group (NYSE:MO) Inc. (MO), Reynolds American Inc (NYSE:RAI). (RAI) are also adapting to the evolving needs of consumers and have resorted to less harmful alternatives like electronic cigarettes (e-cigarettes).

In line with this trend, Philip Morris International (NYSE:PM), Inc. (PM) is working on its portfolio of e-cigarette products called Next Generation Products. These products generate nicotine-containing aerosols by heating a liquid. These will reduce the risks related to tobacco products and attract adult consumers.

Philip Morris also focuses on the development and scientific assessment of non-combustible alternatives to cigarettes, which are referred to as Reduced-Risk Products (RRPs) because they have the potential to reduce the risk of smoking-related diseases.

Acquisitions and Strategic Partnerships

Consumer staples companies are regularly undertaking acquisitions both domestically and internationally to expand their existing customer base and product lines into new markets. Some of them are also forming partnerships, mostly with larger and better known companies, to take a lead in this challenging environment.

Tyson Foods’ merger deal with packaged meat producer, The Hillshire Brands Company in Aug 2014 was the most talked about and the biggest deal in the meat industry. The Jun 2015 merger of Reynolds American – Lorillard in the tobacco industry was also of a similar scale.

Another big merger that happened in Jul 2015 was that of food giants Kraft Foods Group (NASDAQ:KHC), Inc. and H.J. Heinz Company, per a deal announced in March. The newly formed The Kraft Heinz Company (KHC) is now the third-largest food and beverage company in North America and the fifth-largest food and beverage company in the world.

Another mega merger slated to take place is that of Belgium-based beer giant, Anheuser Busch InBev (BUD) and London-based rival, SABMiller (LON:SAB) plc (SBMRY). The merger, which has yet to get U.S. regulatory approval, would combine the two largest beer companies in the U.S. and could have wide implications on the worldwide beer market. The deal is expected to close in the second half of 2016.

Apart from big mergers, there are companies that grow on the back of acquisitions. Treehouse Foods Inc. (THS), which was spun off by Dean Foods Company (DF), has been expanding its product offerings through a number of acquisitions. The acquisition of Private Brands Business in Feb 2016 from ConAgra Foods (NYSE:CAG), Inc. (CAG) generated significant revenues for the company.

Notably, Unilever (LON:ULVR) plc (UL) has been on an acquisition spree since the last few quarters. In September, the Anglo-Dutch buyer announced the acquisition of Vermont-based Seventh Generation Inc. and expressed interest in buying Honest Co., a company co-founded by actress Jessica Alba – which sells disposable baby diapers and other baby products.

Last month, Unilever announced the acquisition of Stockholm-based Blueair, which will complement its water purification business. Unilever also completed the purchase of Dollar Shave Club, which is a men's grooming brand.

United Natural has also been carrying out various acquisitions over the years to grow its distribution network, customer base and boost long-term growth. In 2016, United Natural acquired Gourmet Guru (August), Haddon House Food Products (May) and Nor-Cal Produce, Inc. (April). Prior to that, the company combined Global Organic's operations with its existing Albert's business in the Southeast, after its acquisition in March.

Divestitures

Companies are also focusing on improving their product portfolio through divestitures, which enables them to concentrate on their core portfolio. For example in Oct 2014, Kimberly-Clark Corp (NYSE:KMB). (KMB) spun off its health care business, which is now called Halyard Health, Inc. (HYH). Snacking giant Mondelez International also spun off its coffee business to Netherlands-based coffee company, D.E Master Blenders 1753 in Jul 2015 in order to concentrate on its core snacks business.

Procter & Gamble is near the completion of its divestiture plan and has eliminated almost 60% of the brands (roughly 105 brands) that were witnessing a decline in sales and profits, to focus on more profitable brands.

Similarly, in Nov 2015, General Mills divested its Green Giant and Le Sueur brands of frozen and shelf-stable vegetables to food manufacturer, B&G Foods. The Green Giant buyout will help B&G Foods enter the frozen food business, which according to the company, has tremendous growth potential.

Cost Cutting and Restructuring Initiatives

Most consumer staples companies are implementing cost-reduction initiatives to boost profits. Companies like McCormick, Coca-Cola, Mondelez International, Inc. (MDLZ), Kimberly-Clark, Kellogg Co. (K), Sysco Corp (NYSE:SYY). (SYY), and many others have been benefiting from significant cost savings and restructuring initiatives to boost earnings.

Bottom Line

Given the efforts undertaken by the companies, it is needless to say that investors can cash in on the existing opportunities in the space. How about investing in this space right now?

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

Confidential from Zacks

Beyond this Industry Outlook, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>