Consumer Staples Outlook: Will Weakness Persist? - Zacks Analyst Interviews

The year 2014 started on a weak note for consumer staples companies with concerns over higher gas prices, delayed income tax refunds and higher payroll taxes. Slower recovery in Europe and difficult operating conditions in some Asian countries like China also added to the woes.

Extreme weather conditions affected almost all the consumer staple companies in the first three months of 2014. Though weather conditions improved in the second quarter and the labor market conditions started improving as well, but the overall environment remained unfavorable due to lower consumer demand.

Despite this tough backdrop, the consumer staples sector has done reasonably well this year, beating the S&P 500 index in the year-to-date and trailing 52-week periods. The sector's stock market performance in the last 4, 12, and 24 weeks is roughly in-line with the broader index. This relatively improved stock market performance is likely a reflection of the group's perceived defensive and non-cyclical attributes.

Lackluster top-line growth, lower unit volumes as well as currency headwinds have been a drag on the results of consumer staples companies like The Procter & Gamble Co. PG, Mondelez International, Inc. MDLZ and Kellogg Co. K in the first half of 2014 and have led many of them to provide a weak outlook for 2014. In such a scenario, some of these companies managed to increase their earnings solely with the help of cost controls, inorganic growth and share buybacks, which signals a lack of real growth.

Zacks Industry Rank

Consumer Staples is one the 16 broad Zacks sectors within the Zacks Industry classification. We rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The consumer staples sector is further sub-divided into the following industries at the expanded level (260 industry groups): Beverages – Alcohol, Beverages – Soft, Consumer Products – Miscellaneous Staples, Cosmetics & Toiletries, Food – Meat Products, Food – Miscellaneous/Diversified, Publishing – Newspapers, Soaps & Cleaning Preparations, Textile – Apparel and Tobacco.

The Food – Meat Products industry is the best placed with a Zacks Industry Rank #14, which places it in the top 1/3rd of the 260+ industry groups. It is followed by Beverages – Soft and Textile – Apparel, with a Zacks Industry Rank of #88 and #43, respectively.

Beverages – Alcohol is the only Industry group in the middle 1/3rd portion sharing a common Zacks Industry Rank #106.

The rest of the sub-sectors, Consumer Products – Miscellaneous Staples, Cosmetics & Toiletries, Food – Miscellaneous/Diversified, Publishing – Newspapers, Soaps & Cleaning Preparations and Tobacco are featured in the bottom one-third with a respective Zacks Industry Ranks of #181, #258, #194, #210, #239 and #200.

Looking at the exact position of these industries, one could say that the general outlook for the consumer staples space is negative, as most of the companies suffered from an uncertain macroeconomic environment in the first half of 2014. The companies have provided a soft outlook for 2014, but are hopeful of a recovery through 2015.

Earnings Trends

The consumer staple sector's second-quarter earnings weakness is likely to spill over into the third quarter as sluggish top-line growth, foreign currency headwinds and slowdown in the developing markets continued to nag.

For the 11.8% companies in the consumer staples sector that have already reported the third quarter, the earnings "beat ratio" was 50.0%, while the revenue "beat ratio" was only 25.0%. On a year-over-year basis, total earnings for this sector are expected to decline 0.9% in the third quarter compared with 6.5% growth registered in the second quarter. Total revenue is expected to decline 7.5% in the third quarter against growth of 1.1% in the previous quarter.

The sector so far is expected to contribute 6.7% of the total S&P 500 earnings in 2014, less than its 7.5% market cap weight in the index at present. This signals a difficult consumer spending environment for the third quarter overall. However, as per consensus, earnings are projected to grow 5.4% in 2014, while revenues are expected to decline 6.3% in 2014. For more details about earnings for this sector and others, please read our ‘Earnings Trends' report.

Bottom Line

The sector's operating challenges notwithstanding, consumer staples stocks stand to benefit in the current uncertain market environment given their defensive attributes.