- Large, global consumer goods companies are too expensive.
- Won't provide the same downside protection as previous cycles.
- Shaky balance sheets are a new issue to watch.
This past week serves as a reminder that stocks can decline and that when they do it can happen quickly. As the saying goes, they take the stairs on the way up and the elevator on the way down.
With many investors taking this decline as an opportunity to re-evaluate their portfolios, I wanted to provide a comparison of consumer staples companies today vs. previous cycles and try to provide a few insights on why historical patterns may not repeat.
First, let's start with a quick refresher on history. Investopedia defines consumer staples as "Essential products such as food, beverages, tobacco and household items".
The argument typically goes that these companies should be defensive and outperform the broad market during recessions and bear markets. While consumers may pull back on discretionary purchases like vacations, new clothes, entertainment, they still need to eat and brush their teeth - that stability in demand is valuable.
In recent history, this stability or defensive quality has proven true. For example, in the 2000-2002 bear market the S&P 500 declined 39% and in 2008 it declined over 38% (all price only, not total return). In comparison, the XLP or Consumer Staples Select Sector SPDR ETF lost 14% from 2000-2002 and only 15% in 2008 - or about 1/3 of the downside. There are probably quite a few people increasing or preparing to increase their consumer staples exposure for the next downturn.
Below, I've pulled out a few of the major components of the XLP and other large consumer staples companies to show how they are similar and different from 2000-2002 and 2008. First, valuation...
I looked at the P/E ratio in 1999, 2007 and today - periods before the drawdown started - for the following companies: Procter & Gamble (NYSE:PG), Clorox (NYSE:CLX), Colgate - Palmolive (NYSE:CL), Unilever (NYSE:UL), the S&P Consumer Staples (NYSEARCA:XLP) and the S&P 500. As you can see in the table below, at first glance valuations look reasonable compared to the prior two periods.
In 1999, our four sample companies traded at an average valuation of 34x compared to the market at 29x - or a 16% premium. In 2007, they traded at 21x - or a 23% premium. Today, the valuation is very similar to the 2007 levels at just over 21x and the premium to the market has extended to 24%. So based on P/E multiples you have similar but slightly less valuation protection compared to the last two drawdowns.
But valuation in a bubble doesn't tell you much, next let's take a look at revenue growth. Now these companies are fairly large and in recent years have started to divest non-core brands leading to all sorts of adjustments. I'm using revenue growth as reported by Bloomberg.
In 1999, investors were paying a ridiculous 34x earnings for 2% revenue growth, by 2007 they had come around to their senses and paid 21x earnings for almost 8% revenue growth. Today, investors are paying virtually the same multiple and on average for companies that have a shrinking top line. PEG ratios are tricky things to calculate with negative denominators but I think the point is clear. The valuation support you had in 2007 may not be the same today given slower growth. But let's move on as the above tables leave a bit of a mixed message.
Part of the stability for consumer staple companies comes from the recurring demand from customers but some also comes from the conservative balance sheet. The table below presents net debt as a % of market cap:
|Net Debt as % of Market Cap||1999||2007||Today|
Every company is more levered today compared to 1999 and the average amount of debt is only slightly lower today vs. 2007. 12% today vs. 13.7% in 2007. But levered balance sheets are not the only concern. The table below presents pension obligations as a % of market cap.
|PBO as % of Market Cap||1999||2007||Today|
During the next downturn, creditors will not be the only ones sucking capital away from the companies. Between interest payments on debt and increasing required pension payments these companies have considerably less wiggle room, and their cost structure has shifted from highly variable to increasingly fixed.
Don't get pulled in by dividend yields, valuations are full, debt and pension obligations are increasing and these once stable businesses may not provide much shelter in the next storm.