Consumer Staples - Fisher College of Business

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Student Investment Management
Panchanathan Arthaballe C.
Nishanker Damodara
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Sector Size and Composition
Business Analysis
Economic Analysis
Valuation Analysis
Financial Analysis
Portfolio Recommendation
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A category of industries comprised of those companies
which sell the most common consumer products, such
as food, beverages, house wares, clothing, tobacco and
prescription drugs. (Investorwords.com)
Sector’s products are viewed as basic needs, so
demand is inelastic and relatively constant.
At what point can you not afford to buy toilet paper?
Size of the sector
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S&P Market Cap - $1.1 trillion
5th heaviest weighted sector after IT, Health Care, Industrials & Energy in the SIM portfolio
5th heaviest weighted sector after IT, Financials, Health Care & Energy in the S&P Portfolio
Sector Demographics
Industries segments in the sector
 Agricultural Products
 Brewers
 Distiller & Vintners
 Food Distributors
 Household Products
 Hypermarkets & Supercenters
 Packaged Foods/Meats
 Personal Products
 Retail Drugs
 Retail Food
 Soft Drinks
 Tobacco
Top 10 Market Caps in the sector

SIM holds Wal-Mart stores, P&G, Pepsi and Philip Morris in its portfolio
Market Cap numbers in $ billions
20.00
01/01/2011
10/01/2010
07/01/2010
04/01/2010
01/01/2010
10/01/2009
07/01/2009
04/01/2009
01/01/2009
10/01/2008
07/01/2008
04/01/2008
01/01/2008
10/01/2007
07/01/2007
04/01/2007
01/01/2007
10/01/2006
07/01/2006
04/01/2006
01/01/2006
10/01/2005
07/01/2005

04/01/2005

01/01/2005
Sector Returns for last 5 years
Had positive returns despite deep recession
The returns show gradual and consistent growth for the last 5 years and next 2-3 years
22.00
19.65
18.00
17.66
16.00
14.00
12.00
10.00
Sector Returns 2009 & 2010

11.2% returns for the whole year of 2009 - Modest returns when compared to other sectors
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-1.25% returns YTD (QTD, MTD) in 2010 – compared to -3.6% returns for all stocks in S&P
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Non-cyclical
◦ Inelastic demand of products makes sector a
defensive play.
◦ Underperforms broader market during economic
expansions.
◦ Outperforms broader market in times of economic
contraction.

Competitive Pricing
◦ Pricing usually drives market share.
◦ Price usually supersedes branding as most
important consumer consideration.

High Barriers to entry
◦ Large initial capital outlays require EOS.
◦ New entrants face discounting barriers from
established companies.

Substitution
◦ Undifferentiated, borderline-commodity products
ensure customers are ready and willing to
substitute.
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Domestic
Business:
Mature Phase
International:
Growth Phase
Revenue Growth
16.0%
14.0%
12.0%
10.0%
8.0%
Revenue Growth
6.0%
4.0%
2.0%
0.0%
Eastern Europe, Middle Latin America & Canada
-2.0%
Asia
European Union
East, & Africa
Note:
Figures are net revenues excluding excise taxes and the effect of
currency fluctuations and acquisitions.

Emerging markets
◦ “The World Bank estimates that the global middle class is likely to
grow from 430 million in 2000 to 1.15 billion in 2030. The bank
defines the middle class as earners making between $10 and $20
a day -- adjusted for local prices -- which is roughly the range of
average incomes between Brazil ($10) and Italy ($20).”
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Brand differentiation
◦ Hefty Brand Trash Bags vs Giant Eagle Trash Bags

Product customization
◦ P&G in the Philippines
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Supplier-Retailer Relations
◦ Margin Compression: the Walmart Effect
◦ Global Consolidation in Retail Space:
 Walmart
 Carrefour
 Target
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Excess Capacity
◦ High fixed costs
◦ Under utilization = worsening margins
Sector

Revenues 94-2010
Sector
DPS 94-2010
Sector
Cash Flow/share 01-2010
The Takeaway: the constant upward trend in
revenues, DPS, and cash flows shows that the
sector’s growth and performance is
remarkably insulated from poor economic
conditions.
◦ Despite two major contractions in last decade, the
trend is consistently upward.
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Macroeconomics over Microeconomics
◦
◦
◦
◦
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Unemployment rates
GDP growth
Commodity prices: inputs and energy
Interest Rates
Exchange rate fluctuation.
◦ “Foreign exchange reduced P&G’s fiscal 2009 sales
by about four percentage points, or approximately
$4 billion, and profit by more than $1 billion.”
(2009 Annual Report)
◦ Currency fluctuations can help or hurt the sector.
Financial Analysis
Revenue (Per Share)
Revenue per share expected to increase gradually in the coming years
At the S&P level, revenues are still decreasing post-Lehmann collapse
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
Revenue Per Share – Sector
Revenue Per Share - S&P 500
1100.00
341.42
333.03
340.00
1061.28
1013.57
1000.00
301.41
290.00
945.17
941.02
900.00
270.75
871.58
245.55
240.00
800.00
777.70
203.97
190.00
700.00
178.28
695.36
675.93
01/01/2010
01/01/2009
01/01/2008
01/01/2007
01/01/2006
01/01/2005
01/01/2004
01/01/2003
01/01/2002
01/01/2001
01/01/2000
01/01/2010
01/01/2009
01/01/2008
01/01/2007
01/01/2006
600.00
01/01/2005
01/01/2004
01/01/2003
01/01/2002
01/01/2000
01/01/2001
163.65
160.87
148.74
140.00
732.41
712.28
18.21
01/01/2011
08/01/2010
03/01/2010
20.00
10/01/2009
05/01/2009
12/01/2008
07/01/2008
02/01/2008
09/01/2007
04/01/2007
11/01/2006
06/01/2006
01/01/2006
08/01/2005
03/01/2005
10/01/2004
05/01/2004
12/01/2003
07/01/2003
02/01/2003
09/01/2002
04/01/2002
11/01/2001
06/01/2001
01/01/2001
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08/01/2000
03/01/2000
Earnings Per Share
EPS is set to increase due to
o
Consolidations in industries like soft drinks, packaged foods etc.
o
Realizing the value of job cuts and other cost cuttings
o
Expansion into relatively inexpensive global markets
25.00
19.65
15.00
10.00
5.00
0.00
EPS – Relative to S&P 500

EPS relative to S&P would decrease due to
o
EPS in other industries bouncing back to non-recession levels
o
The defensive nature of the sector
50.0
40.0
38.1
36.6
32.0
26.9
26.1
30.0
20.0
33.2 32.3
31.9
28.5
27.2
17.0
15.1
10.0
13.6
9.1
0.0
-6.4
-9.8
-10.1
-10.0
4.8
1.3
-0.4
-4.1
22.5
18.2
20.3
-1.7
-5.4
-6.4
-6.8
-6.8
-7.4
-8.2
-8.6
-9.2
-10.7
-13.2
-16.7
-6.8
-1.9
-9.2
-15.4
-19.0
-23.1
-23.1
-20.0
-18.3
-19.4
03/01/2011
11/01/2010
07/01/2010
03/01/2010
11/01/2009
07/01/2009
03/01/2009
11/01/2008
07/01/2008
03/01/2008
11/01/2007
07/01/2007
03/01/2007
11/01/2006
07/01/2006
03/01/2006
11/01/2005
07/01/2005
03/01/2005
11/01/2004
07/01/2004
03/01/2004
11/01/2003
07/01/2003
03/01/2003
11/01/2002
07/01/2002
03/01/2002
11/01/2001
07/01/2001
03/01/2001
11/01/2000
07/01/2000
03/01/2000
-30.0
EBITDA Margin - Absolute
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EBITDA margins have been increasing and is expected to increase for one or two more
years due to
o
Consolidations in industries like soft drinks, packaged foods etc.
o
Cost cutting activities, employee layoff, outsourcing etc.
15.00
14.50
14.60
14.40
14.00
13.80
13.50
13.00
12.60
12.50
12.50
12.40
12.00
12.00
12.00
12.00
12.00
11.50
11.10
11.00
10.50
12/01/2009
08/01/2009
04/01/2009
12/01/2008
08/01/2008
04/01/2008
12/01/2007
08/01/2007
04/01/2007
12/01/2006
08/01/2006
04/01/2006
12/01/2005
08/01/2005
04/01/2005
12/01/2004
08/01/2004
04/01/2004
12/01/2003
08/01/2003
04/01/2003
12/01/2002
08/01/2002
04/01/2002
12/01/2001
08/01/2001
04/01/2001
12/01/2000
10.00
EBITDA Margin relative to S&P
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EBITDA margins are always less than the overall S&P average due to the nature of the
business in the sector – most of the products are commodity products and compete
based on price and hence have lower EBITDA margins
EBITDA margins has been improving for the last two years as revenues have been
increasing and hence achieving economies of scale
0.85
0.80
0.80
0.75
0.73
0.70
0.68
0.67
0.65
0.60
0.60
0.58
0.55
0.56
0.58
0.56
0.50
0.50
0.47
0.45
12/01/2009
12/01/2008
12/01/2007
12/01/2006
12/01/2005
12/01/2004
12/01/2003
12/01/2002
12/01/2001
12/01/2000
0.40
Net Profit Margin - Absolute
7.50
7.15
7.00
6.50
6.29
6.00
5.83
6.33
5.94
5.50
5.28
5.00
4.50
5.14
5.14
5.21
5.17
Net Profit Margin relative to S&P
1.10
1.02
1.00
1.00
0.90
0.80
0.70
0.60
0.81
0.79
0.74
0.69
0.61
0.60
0.55
0.50
0.40
0.82
24.20
22.00
21.10
12/01/2009
08/01/2009
21.10
04/01/2009
12/01/2008
08/01/2008
04/01/2008
12/01/2007
08/01/2007
24.70
04/01/2007
12/01/2006
08/01/2006
24.00
04/01/2006
12/01/2005
08/01/2005
29.00
04/01/2005
12/01/2004
28.00
08/01/2004
29.90
04/01/2004
12/01/2003
08/01/2003
30.00
04/01/2003
12/01/2002
08/01/2002
34.00
04/01/2002
12/01/2001
08/01/2001
36.00
04/01/2001
12/01/2000
Return on Equity - Absolute
34.80
34.10
32.00
28.60
26.00
22.60
22.30
20.00
18.00
Return on Equity relative to S&P
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2.40
ROE relative to S&P would decrease towards historical levels due to
o
Revenues in other industries bouncing back to non-recession levels
o
The defensive nature of the sector
2.26
2.20
2.12
2.00
1.98
1.80
1.79
1.77
1.84
1.64
1.60
1.40
1.41
1.40
1.20
1.18
1.15
1.00
12/01/2009
08/01/2009
04/01/2009
12/01/2008
08/01/2008
04/01/2008
12/01/2007
08/01/2007
04/01/2007
12/01/2006
08/01/2006
04/01/2006
12/01/2005
08/01/2005
04/01/2005
12/01/2004
08/01/2004
04/01/2004
12/01/2003
08/01/2003
04/01/2003
12/01/2002
08/01/2002
04/01/2002
12/01/2001
08/01/2001
04/01/2001
12/01/2000
0.80
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Revenues is expected to increase gradually and also relative to S&P
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EPS is expected to increase
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EBITDA Margin are expected to improve towards normal nonrecession levels
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Net Profit Margin is to increase gradually and also relative to S&P
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ROE is expected to increase slightly but decrease overall relative to
S&P
Valuation Ratios - Absolute
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All the current valuation ratios are less than the median values for the past 10 years
P/FE, P/TE are very much less than the average because of doubts in

Long term growth potential (especially in volatile international markets)

Changing consumer habits
Valuation Ratios relative to S&P
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All the current valuation ratios are less than the median ratios
Historically almost all valuation multiples for the consumer staples sector is greater than
the overall S&P average
Forward P/E – Industry breakup
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Brewers and Retail Drugs are trading at a very low P/E compared to their medians
Walgreens and CVS (Retail Drugs) are expected to a grow at much lower rates than pre
recession levels
P/E – Trend over last 10 years
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All current valuation ratios are lower than the historical median
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The valuation ratios have been expanding from the start of 2009

The ratios are expected to expand as doubts about economic
recovery in various markets, consumer habits etc., are cleared over a
period of time

Certain industries like Retail drugs, breweries are not expected to
have pre-recession growth levels and hence valuation ratios are
expected to be well below (contraction) the median for these cases

The market has recovered too quickly and current valuations
are inflated due to overly optimistic assumptions about the
speed of a future recovery.
◦ History repeats itself… to a certain degree.
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Expect a sharp correction in the near to midterm to be
followed by very gradual growth.

What should be a robust recovery will be hampered
by:
1) Record government deficits.
2) Higher taxation.
3) Weakness in consumer spending.
4) Limited credit and lending due to higher lending
standards.
◦ 5) Potential for inept government actions.
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Increase weight of Consumer Staples sector by 30
basis points to 12.26%. The current weight of the
sector is 11.96% compared to S&P’s 11.65%.
Provides a defense against a market pullback.
Still in a position to benefit from the emerging
markets growth story.
Market direction is currently uncertain and until it
becomes more clear, it will be best to remain
defensive.
◦ Signs of direction:
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Unemployment figures.
Consumer spending and confidence data
GDP growth
Energy prices
Interest rates and FOMC minutes
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