PowerShares S&P SmallCap Consumer Staples Portfolio (PSCC) is in the Danger Zone this week. Despite the Consumer Staples Sector being ranked #1 in my Sector Rankings for ETFs and Mutual Funds report, PSCC is one of the worst sector ETFs I cover.
You cannot trust ETF labels. You need to assess ETF holdings.
There is no guarantee that any two Consumer Staples ETFs are going to be comparable in terms of holdings or performance. Just look at PSCC compared to Consumer Staples Select Sector SPDR (XLP), my highest rated Consumer Staples ETF and top-rated ETF across all sectors. 45% of PSCC's funds are allocated to Dangerous-or-worse rated stocks compared to only 2% for XLP. Conversely, XLP allocates over 66% of its capital to Attractive-or-better rated stocks compared to 12% for PSCC.
In fact, the two ETFs have zero holdings in common. The only thing that links the two is the Consumer Staples classification, and even that name is slightly misleading. Nearly 15% of PSCC's value is allocated to stocks classified as either Industrials or Materials.
The biggest difference is that XLP allocates mostly to large cap stocks while PSCC mostly allocates to small caps, which get worse ratings overall. However, this should not make it impossible for PSCC to hold Attractive stocks. Inter Parfums, Inc. (IPAR) is my top rated Consumer Staples stock and has a market cap of only ~$800 million.
The problem is that PSCC, for the most part, does not hold many Attractive stocks, and it allocates a small amount of capital to those few that it does hold. Not surprisingly, its two top holdings, The Hain Celestial Group (HAIN) and TreeHouse Foods (THS) both earn a Dangerous rating.
HAIN is one of my least favorite stocks held by PSCC. It has not earned positive economic earnings in any year since the beginning of my model in 1999. Also, since 1999, free cash flow has been negative every year except for one year for cumulative loss of -$1.1 billion of free cash flow. Meanwhile, the company's debt load has increased consistently along with the valuation of the stock.
The market is quite optimistic about HAIN's future profits. The current share price of ~$62 implies that HAIN will grow after tax profit (NOPAT) by 15% compounded annually for 13 years. Those are high expectations for any business. They seem to imply that HAIN will achieve dominant market share and position in the natural and organic food business, which will only become more competitive in the future. I think all the upside in this stock is in the past while plenty of risk remains.
Excessive allocation to HAIN and other Dangerous stocks explains why PSCC manages to be one of my worst rated ETFs even though it is in the top rated sector. I expect most Consumer Staples sector ETFs to rise while PSCC looks more likely to sink.
Sam McBride contributed to this article.
Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.