Are Consumer Staples Stocks Poised for Strong Growth in 2016?

The Fed's decision to leave the door open for another rate hike in March has added to market uncertainty. But the reality is that hardly anyone in the market believes the Fed will follow through with its December dot-plot that indicated four rate hikes in 2016. With Europe and Japan clearly doubling-down on their easing measures, the Fed would effectively be causing the dollar to gain further ground and add to the export sector's existing woes.

The weak Q4 GDP showing notwithstanding, the overall outlook for the U.S. economy remains favorable, with steady labor market gains and oil savings helping household spending. While wage gains haven't kept pace with broader favorable momentum in labor market, a number of retailers and fast food chains including Wal-Mart Stores, Inc. WMT, McDonald's Corp. MCD, Target Corp. TGT and The TJX Companies, Inc. TJX have hiked wages.

The growth outlook for the global economy is no doubt uncertain, but the stable fundamentals of the U.S. economy mean that we can sustain a moderate growth pace despite the challenges. This is a favorable backdrop for the consumer staples industry, with lower commodity prices helping margins for a number of sector operators, offsetting part of the negative impact of unfavorable currency movements.

Here are some of the key factors that have been driving consumer staple stocks since the past few quarters 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. 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.

Keurig Green Mountain, Inc. GMCR has stirred up a revolution with its innovative and exclusive offerings in its single-serve coffee category in order to remain competitive. In September, with the launch of its much-hyped product – Keurig KOLD brewer, it entered the cold beverage space, which is five times the size of the hot beverage market. Keurig has also partnered with The Coca-Cola Company KO and Dr Pepper Snapple Group, Inc. DPS to make Coca-Cola and Dr Pepper branded single-serve pods for use on its Keurig Cold at-home beverage system.

For the hot brewer, the company already has strategic agreements with several other coffee and beverage companies like Starbucks Corp. SBUX, Unilever plc UL, Eight O Clock, and Dunkin Donuts DNKN to offer signature drinks of these companies in Keurig Green Mountain's K-Cups and Vue packs.

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.

America's largest soft drinks makers -- The Coca-Cola Company, PepsiCo, Inc. PEP and Dr Pepper Snapple -- have pledged to reduce calories in their beverages by 20% by 2025 due to a significant customer shift toward healthier and more nutritious products. Accordingly, the companies agreed to promote bottled water, no-or-lower-calorie beverages and smaller portion sizes to its consumers. Coca-Cola's bottler Coca-Cola Enterprises Inc. CCE also committed recently to lower calories in its soft drinks by 10% per liter by 2020.

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

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

To cater to this, Philip Morris International, Inc. PM is also 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.

Acquisitions and Strategic Partnerships

Consumer staples companies are regularly carrying out 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.

Another big merger happened in Jul 2015 that of food giants -- Kraft Foods Group, 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.

In mid-January 2016, Pinnacle Foods Inc. PF completed the acquisition of Boulder Brands, Inc. for $975 million, including debt. The transaction expands Pinnacle's presence in the natural and organic retail channel and provides Pinnacle with a new growth platform in refrigerated foods.

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. Similar was the merger of Reynolds American – Lorillard in the tobacco industry.

Further, Belgium-based beer giant Anheuser Busch InBev BUD is considering taking over its London-based rival, SABMiller plc (SBMRY). The proposed merger, expected to close in the second half of 2016, would combine the two largest beer companies in the U.S. and could have wide implications on the worldwide beer market.

Another major buyout announcement was that of Keurig Green Mountain, Inc. in December 2015, where Keurig agreed to sell itself to an investor group led by JAB Holding Company (‘JAB'), a Luxembourg based private company, for $13.9 billion. The deal, expected to close in the first quarter of 2016, will provide significant cash value for its shareholders, who have seen share prices fall since the beginning of 2015.

Divestitures

The companies are also focusing on rationalizing their product portfolios through divestitures, which enables them to concentrate on their core portfolio.

Procter & Gamble plans to divest roughly 100 brands that were witnessing a decline in sales and profits in order to focus on more profitable brands.

Similarly, in Oct 2014, Kimberly-Clark Corp. 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.

In Nov 2015, General Mills also 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 & Co., Inc. MKC, Mondelez International, Inc. MDLZ, Kimberly-Clark, Kellogg Co. K, Sysco Corp. SYY and many others have been benefiting from significant cost savings and restructuring initiatives to boost earnings.

Bottom Line

The Consumer Staples space offers plenty of opportunities for savvy investors. The sector more than makes up for the lack of strong growth with stable and visible operations and a relatively low-risk profile.

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

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