October 18, 2007
Consumer Industry Report
Cat Duncan, Kayley Laren, Valerie Liu, Alex Messiter
Description
The following descriptions seek to detail the size and nature of the Consumer industry at the
level of three sectors, Consumer Staples, Consumer Discretionary Manufacturing, and
Consumer Discretionary Services.
Consumer Staples
Within the consumer products industry, there are two broad types of companies: those that sell
or manufacture goods that customers would like to purchase provided that they have the extra
money with which to do so, and those that sell or manufacture goods that customers feel that
they need for their daily lives. While the former group is known as the consumer discretionary
sector, the latter group is known as the consumer staples sector, which includes tobacco,
personal products, household products, food & beverage and food & staples retailing
(BusinessWeek.com). Notably, this group contains a wide variety of companies that produce
and sell a large mix of products. However, the common trait linking the companies in this
sector is that companies that manufacture or distribute consumer staples are generally not very
vulnerable during economic downturns. After all, while someone who has lost a job or faced a
pay cut may not buy a new television, they will almost certainly still buy toothpaste (Forbes).
Thus, during bear markets, companies in the consumer staples sector tend to perform better
than companies in other industries since there is relatively stable demand for consumer staples
products (StreetAuthority.com).
Consumer Discretionary: Manufacturing
The Consumer Discretionary: Manufacturing sector consists of goods (not services) that are
subject to cyclical demand prompted by seasonal changes and underlying economic factors. As
there is not inelastic demand for these types of goods, corporate performance and equity
valuation should vary with the perception of the broad economic situation. As such, consumer
discretionary stocks are poised to capitalize on an economic expansion but also face a larger
downside risk than stocks of companies providing consumer staples. That said, different
companies within the sector still vary in their sensitivity to economic cycles according to their
distinct clientele. In particular, this sector includes companies in the following industries:
automotive, household durable goods, textiles & apparel, and leisure equipment.
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Consumer Discretionary: Services
The services sector of the consumer industry encompasses hotels and motels, restaurants,
home improvement, catalog and mail order, grocery, apparel, specialty retail, and department
and discount retail. This sector comprises $320 billion in the US market. The major companies
in this industry cater to the bulk of American consumers and are understandably predominantly
large chain stores whose names are well recognized by American households. The primary
exception to this would be those players in the specialty retail subsector which are more
commonly operated as boutique stores with fewer clientele but with the same power of name
brand recognition.
The primary market for these services is a very broad one because these are services sought by
the common American. The market spans the country but is concentrated in areas of higher
populations. Because this sector is highly mature and saturated, it also shares a great degree of
consolidation, as many of these subsectors are interrelated with each other.
Valuation Metrics
The following valuation metrics are important measures of performance within the consumer
industry.

Earnings per Share (EPS) = Net earnings/ Total shares
Measures the increase in value of one share of company stock. Greater EPS indicates that a
stock that gained more in value and has been a relatively good investment.

Price to Earnings (P/E) Ratio = Current stock price / Earnings per Share
Measures how expensive a stock is. High P/E ratios are usually associated with stocks that are
popular among investors. A stock’s relative expensiveness can be justified by its high expected
growth rate.

Price/Earnings to Growth (PEG) Ratio = P/E Ratio / Expected growth rate of EPS
Measures the expensiveness of a stock with respect to its expected increase in earnings. In
efficient markets, stock prices generally match growth expectations, so PEG ratios are close to 1.

Return on Equity (ROE) = Net income / Total shareholders’ equity
Measures the likelihood of shareholders’ receiving dividends (income is either reinvested in the
company or transferred to shareholders as dividends). Greater ROE indicates possibility of
greater returns.
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
Same Store Sales / Comps = Sales per given time period
Sales from a given store. Usually recorded monthly, this metric is used to distinguish sales
growth in existing stores from sales growth resulting from the establishment of new stores.
Assuming constant costs, greater sales figures are an indicator of greater profit.

Gross Margins = (Sales – Cost of Goods Sold) / Sales
Measures the revenue generated per dollar of sales. Used to measure how efficient a company
is at deriving profit from selling goods.

Sales per Square Foot = Sales / Square footage of retailer
Used to measure the productivity of a company at generating sales from the input of real estate.

Inventory Turnover = Sales/Inventory or Cost of Goods Sold/Avg Inventory
Used to measure how many times a firm’s inventory is sold and replenished over a given time
period. Greater figures indicate strong sales or poor choice of inventory purchase on the part of
the retailer.
Trends/Industry Drivers
The following section seeks to identify the major trends that drive performance in the three
sectors within the Consumer industry.
Consumer Staples
The current economic troubles, which can be characterized by the weak housing market, the
decreasing value of the US dollar, and the recent credit crunch (AP), may take a toll on
discretionary spending this year, particularly during the holiday season (Forbes). Given the
defensive nature of consumer staple stocks, then, one should expect them to outperform the
S&P 500 in such uncertain economic circumstances. Indeed, shares of Proctor & Gamble, for
instance, have increased 9% since the beginning of September, while shares of Colgate
Palmolive Co. are up about 10% over the same period (AP).
Within several subgroups of consumer products, there are further recent trends worth noting.
In the food and staples retailing industry, both CVS and Wal-Mart have announced plans to
open in-store clinics staffed by nurse practitioners. Target and Walgreens already have a
limited number of clinics in some of their stores (Smartmoney.com) This trend could add to
profits for these retailers by increasing sales volume as the chance to have quick and hasslefree medical care for minor ailments might bring more customers into the store (not to mention
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virtually ensure that they then fill their prescriptions at the store). Thus far, however, such
programs appear to have had little impact on companies’ profits (Smartmoney.com).
In the tobacco industry, high lobbying, legal fees, and restrictive legislation, including both
smoking bans in restaurants and bars and higher taxes on cigarettes, continue to be a
substantial threat (CNNMoney.com). Largely as a response, cigarette companies including
Phillip Morris and Altria have begun to raise prices, and, in the case of Altria, to concentrate on
sales overseas where anti-smoking campaigns are not yet as prevalent (CNNMoney.com)
At the same time, a variety of companies in the consumer staples industry are highly affected
by the surge in commodity prices. In particular, the food and beverage industry has seen rising
input costs due to China’s increasing demand for raw materials including grain and beans, the
growing use of foodstuffs such as corn, wheat and sugarcane for manufacturing forms of
alternative energy including ethanol and biodiesel, and the weakness of the US dollar (AP). As a
result, food manufacturers have been raising prices, causing what the Associated Press refers to
as the “worst food inflation since 1990” (AP). Nonetheless, the beverage industry has benefited
from increasing sales volume of non-carbonated drinks and strong overseas growth rates
(MarketWatch).
Consumer Discretionary: Manufacturing
In the automotive industry, which is at the core of the manufacturing sector, the rising price of
oil (approaching $90/barrel) has sparked innovation. With the increasing price of gas,
consumers have been increasingly drawn to hybrid and other fuel-efficient cars. In the first 7
months of 2007, hybrid sales were up 49% in the U.S. Not only have manufacturers increased
sales by catering to this consumer concern, but efforts to make models more fuel-efficient have
resulted in a better public image and brand association, as consumers have increasing favored
environmentally-conscious firms and products. General Motors, which initially trailed Toyota
and other foreign manufacturers in developing and retailing cars powered by alternative energy,
recently unveiled a plug-in electric vehicle.
Manufacturers, struggling to compete with foreign producers facing much smaller labor costs,
have been increasingly focused on their core business and have been paring inefficiencies.
Notably, General Motors recently announced it would fire 767 employees at a plant in Detroit
and signaled that other firings would follow. With increasingly global competition, outsourcing
continues to be an attractive option, and many firms, including General Motors, have partnered
with local firms in China and India in order to take advantage of the lower cost of labor.
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Another large trend in the manufacturing sector is the growing focus on international markets.
As an example, Chrysler, the automaker most dependent on domestic sales, announced its
intention to boost international sales to half its total. Not only will firms with a strong
international presence benefit in the short-term as a result of a weaker dollar, but these firms
will also benefit in the long run from a growing overseas market, especially in fast-growing
countries like China and India. As a point of reference, in the first nine months of 2007, car
sales in China alone rose 24% to 4.58 million. Nike sales in China are growing at over 50%
annually and are expected to total $1 billion within the year. Additionally, by placing a greater
emphasis on international sales, companies diversify their revenue stream and are less sensitive
to poor domestic macroeconomic conditions.
Consumer Discretionary: Services
A common trend shared by the food and beverage and hospitality industries is expansion. For
food and beverage companies, this desire is still contained mostly in the US where leading
family restaurants such as IHOP, Ruby Tuesday, and Applebee’s remain concentrated in one
geographical region, if not sparsely spread throughout the States. In any case, the food and
beverage industry as a whole is already saturated to the extent that additional expansion will be
unlikely to make a dramatic effect in the industry as a whole.
A much more dramatic expansion outlook can be seen in the hospitality industry, particularly in
the plans of Starwood Hotels and Marriott International. With North America drawing less and
less appeal, conglomerates have set their sights on the Asia-Pacific region, especially as tourist
destinations in Thailand, China, and India become increasingly popular. Specifically, Starwood
has been striking partnerships with travel agencies specializing in Asia-Pacific tourism as well
as joint ventures with property developers in Asia. Meanwhile, Marriott has plans to open at
least 60 more hotels in the next three years to add to its Asia-Pacific presence, no doubt
creating fierce competition on international turf for the hospitality industry. Much of the appeal
in the Asia-Pacific region lies in low costs and a relatively unsaturated market with respect to
tourism and hospitality.
Key Players
Consumer Staples
Key players in the consumer staples sector can be divided into five subgroups: tobacco,
personal products, household products, food & beverage and food & staples retailing
(BusinessWeek.com).
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
Altria (MO): The world’s second-largest tobacco firm and the parent company of Philip
Morris.

British American(BTI): Sells over 300 cigarette brands including Pall Mall, Lucky Strike and
Kent.

Reynolds American (RAI): Produces domestic lines of cigarettes including Winston and
Camel as well as Grizzly, the fastest-growing discount brand (Morningstar).

Avon (AVP): The largest direct seller of cosmetics worldwide.

Colgate-Palmolive (CL): One of the world’s largest manufacturers of toothpaste and laundry
detergents and also makes products including pet food and deodorant (Morningstar).

Home Depot (HD): The retailer of home-improvement products worldwide.

Walmart Stores (WMT): The world’s largest retailer (Morningstar).

Proctor & Gamble (PG): Manufactures brands such as Charmin toilet paper, Pantene hair
products, Cover Girl cosmetics, and Iams pet foods and is the world’s largest consumer
products manufacturer.

Coca-Cola (KO): The world’s largest beverage company, KO manufactures beverages that
include Coca-Cola, Sprite, Fanta and Dasani (Morningstar).
Consumer Discretionary: Manufacturing

General Motors (GM): With a market cap of $21.6B, General Motors is the biggest player in
the U.S. automotive industry. Through different brands like Chevrolet and Saab, GM caters
to different clientele. For example, the Chevrolet brand is known for its trucks and is
targeted at rural Americans. Additionally, due to the competitive international nature of the
automotive market, one of the main selling points for GM is the American-made nature of
its autos.

Nike (NKE): $30.3 B market cap. Purveyor of clothing and equipment used in athletics,
including sport-specific merchandise. Alongside its main business, Nike includes the
subsidiary brands Cole Haan, Bauer Hockey, Hurley International, Converse, and Exeter.
Nike also is undeniably a fashion brand, due largely to the star-studded nature of its
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advertising. As such, it caters to a relatively upscale clientele, although new initiatives have
been enacted to try and attract more value-conscious consumers. Nike is well poised to
take advantage of the growing overseas market, as international sales make up around 60%
of total revenues.
Consumer Discretionary: Services

Starwood Hotels & Resorts Worldwide, Inc. (HOT): Starwood’s brand names include St. Regis
Hotels & Resorts, The Luxury Collection, W Hotels, Westin Hotels & Resorts, Le Meridien,
Sheraton Hotels & Resorts, Four Points by Sheraton, aloft, and Element with a combined
market cap of $12.65 billion. With its latest partnership with Agoda, an online travel
company specializing in hotel discount bookings in Asia, revenue from Starwood’s Asia
properties is expected to rise.

Marriott International, Inc. (MAR): Marriott is a worldwide operator and franchisor of hotels
and related lodging facilities. The company’s operations are grouped into the six business
segments: North American Full-Service Lodging, North American Limited-Service Lodging,
International Lodging, Luxury Lodging, Timeshare and Synthetic Fuel. Marriott has just
teamed up with Conde Nast Traveler to auction off 20 dream vacations for charity.

Ruby Tuesday, Inc. (RT): Ruby Tuesday owns and operates Ruby Tuesday concept in the bar
and grill segment of casual dining and also offers franchises for the Ruby Tuesday concept
in domestic and international markets. As of June 5, 2007, the franchise partnerships
operated 154 restaurants, and traditional franchisees operated 45 domestic and 54
international restaurants. Ruby Tuesday is still concentrated primarily in the Southeast,
Northeast, Mid-Atlantic and Midwest of the United States but there is much potential growth
to be had on the West Coast.
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