PEJ: Is It Too Soon to Dive Back into a Leisure and Entertainment ETF?

While the current economic pullback has caused many investors to tighten their belts and cut back on discretionary spending, glimmers of hope have appeared in the entertainment and leisure sector. The PowerShares Dynamic Leisure & Entertainment Portfolio (PEJ) has recently jumped in our Sector Momentum Tracker ETF Rankings, moving from the No. 43 spot on January 27, 2009, to the No. 15 spot on April 21. The stocks that have bounced the farthest in 2009 are those that fell the most dramatically in 2008, a phenomenon witnessed by many of PEJ’s top components. This bounce, along with a consumer shift toward less expensive discretionary services, should continue to be monitored by prospective PEJ investors as earnings make headlines in 2009.

PEJ is designed to track the Leisure and Entertainment Intellidex, which comprises 30 U.S. leisure and entertainment companies. These companies do everything from television to sporting goods to restaurants and casinos. The definition of the index is broad, and the companies it contains include familiar household names and smaller holdings. More than 50% of PEJ’s allocation was classified as “small cap” according to PowerShares. As of December 31, 2008, 75.84% of PEJ’s portfolio was allocated toward “hotels, restaurants and leisure” while 17.82% and 6.22% of shares were allocated toward “media” and “Internet and catalog retail,” respectively.

After a precipitous fall in late December, shares of PEJ top-component Starbucks (SBUX) have rebounded strongly in 2009. Responding to dismal economic conditions, SBUX slowed its viral growth and shuttered some underperforming branches in late 2008, as share price fell dramatically from 2007 highs. Deemed by some to be the epitome of discretional spending, SBUX has been one of the greatest growth—and subsequent loss—stories in recent years. If downward pressure lightens up as cost-cutting measures are implemented, SBUX could prove to be oversold and potentially find room to grow once again in a more stable economy.

PEJ’s No. 2 holding, Darden Restaurants (DRI), has more than doubled in price since late 2008. DRI’s recent earnings jump is a testament to the power of not-so-bad news—while EPS from continuing operations slid, the dip was not nearly as bad as expected. Is “not-so-bad” good enough? Diners at DRI’s Red Lobster, LongHorn Steakhouse and Olive Garden establishments have proved resilient, while cost-cutting diners at competing restaurants added to their ranks. ChangeWave’s March survey of U.S. consumers revealed that one in three consumers planned to change his or her habits and favor less expensive restaurants. This shift could bode well for family-friendly names in DRI’s portfolio.

Carnival Corp. (CCL), PEJ’s third-largest holding, has also seen a surge in share price in 2009 despite bleak forecasts. In late 2008, CCL announced that 2009 would likely be difficult, as year-over-year bookings and occupancy rates were already lower than the 2008 figures. The recent outbreak of swine flu has done little to comfort investors or travelers, resulting in a more than 13% slip in CCL’s stock price on April 27. In response to the concern, CCL, the world's largest cruise line, announced that day that there had been no reports of passengers exhibiting symptoms of swine flu on its ships. “We do not anticipate that our guests’ cruise experience will be impacted by this type of illness and will not be making any adjustments to our itineraries,” company officials noted.

Other popular PEJ components also confirm recent trends and reflect consumer habits. Earnings coming from other top PEJ components such as McDonald’s (MCD) have confirmed to many investors that the “trade down” trade is alive and well. A recent pop in P.F. Chang’s (PFCB) stock price has some analysts wondering if a return to high-end casual dining is inevitable, but this could take a considerable amount of time. Other popular trends include investment opportunities in the quick service category. Yum Brands (YUM), PEJ’s fifth-largest component, recently beat forecasts, with sales in its China stores increasing 2%.

The recent outperformance of PEJ’s portfolio has helped the fund gain momentum quickly, but investors should still consider the risks of any niche investment before purchasing shares. While volume has been improving, PEJ’s three-month average daily trading volume is still less than 20,000 shares, making this product relatively illiquid. As noted in iShares’ prospectus for PEJ, “Leisure and entertainment industry concentration risk companies... may become obsolete quickly”—the downside of the enormous power of the trend.

Comments

[mrmillergd:]

This would seem to be a bit too diversified to be a true "entertainment" etf. Component companies all have substantially different debt burdens and structures.

I like the fast food rests like MCD and SBUX - these continue to have great cash flow. I worry about other components though.

Apr 29 09:50 PM

[Tony Roberts:]

Great detailed article on the ETF. Thanks for the article

Apr 29 10:49 PM

[RiskReturnO...:]

Careful with this sector as consumer spending uptick may be temporary. Also, swine flu news not helping this sector. Wait for pullback before commiting new capital.

Apr 30 01:43 PM