Consumer staples stocks had a tough week. The picture looks even worse compared with discretionary peers. Yet this may be the new normal for the group, meaning investors need to get choosy.
The
Consumer Staples Select Sector SPDR
exchange-traded fund (ticker: XLP) fell more than 3% over the past five days, even as the
Consumer Discretionary Select Sector SPDR
(XLY) gained ground. As Wells Fargo analyst Chris Carey wrote in a recent note, that means staples had its worst underperformance versus discretionary since the start of the year.
That was in the midst of the January rally, when investors abandoned the havens they flocked to during 2022’s bear market as they regained their appetites for risk. Since then, staples have gotten a bit of a bounce during times of market turmoil, like the banking crisis, but by and large have been left behind. Year to date, XLP is down more than 1%, even as the S&P 500 has climbed more than 9%, and XLY has notched gains more than double that.
Still, discretionary’s pronounced outperformance may seem counterintuitive this week, given that the market has gotten mixed signals from recent retail earnings reports about consumers’ ability to keep spending on things that are nice, rather than necessary, to have.
However, the past few days have brought some solid reports that show higher-income consumers at least still have some desire to keep spending on nonessentials, as evidenced by results at
Ralph Lauren
(RL),
Urban Outfitters
’ (URBN) Anthropologie and Free People brands, and
Abercrombie & Fitch’s
(ANF) flagship stores, among others.
That said, as Carey notes, Wall Street analysts are still bringing down their earnings estimates for discretionary companies. But “estimate cuts appear to be bottoming in consumer discretionary and the stocks are rallying,” he writes.
At the opposite end of the spectrum, he argues that staples’ best results may be in the rearview mirror: “We think organic sales growth peaked in the fourth quarter, with gross margin expansion peaking in the first quarter, levels we may not see again in a generation of Staples investing…and we are now firmly on the deceleration curve…a less interesting place to be.”
At the same time, staples valuations remain high after their 2022 surge, and sit at multiyear highs despite their 2023 underperformance. That makes it even more difficult for investors to put new money to work in the stocks.
Of course, staples have bounced back plenty of times over the past three years, so they could do so again. Yet Carey warns that “after many false starts, it feels like the end of an era….this feels different, and it’s time to start thinking about the ‘Last Stand’ of this staples cycle (while possibly ready to scoop up good companies that overshoot down).”
However while he thinks it’s time for investors “position for the likely end of ‘safety at all cost,’” that doesn’t mean they have to abandon the category altogether. He notes that stocks with any combination of durable volumes, attractive relative valuations, and some margin recovery remaining are worth watching at the very least.
On these metrics,
Keurig Dr Pepper
(KDP) screens the best, as the company saw a 3.4% compound annual growth rate, or CAGR, in volumes in the first quarter versus 2019, even as its forward price-to-earnings ratio is below its five-year average and gross margins are still at prepandemic levels (leaving room for further expansion).
Barron’s noted many similar catalysts when we highlighted the stock in February.
Carey notes that
Constellation Brands
’ (STZ) volume CAGR is also “top tier” even as the shares trade at a discount to historical averages and beer margins at least are below 2019 levels.
Coca-Cola
(KO) also looks intriguing, he writes, as it has the second best volume CAGR among large-cap staples while trading at a discount to its five-year average.
Mondelez International
(MDLZ), which Barron’s also highlighted late last year, seems expensive given its valuation, but he notes that it compensates given its volume CAGR and room for margin growth.
Write to Teresa Rivas at teresa.rivas@barrons.com
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