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Consumer Staples No Longer a Sure Bet

High valuations make them less defensive if there's a downturn

By Daniel Putnam, InvestorPlace Contributor


Investors have come to expect that when the market starts falling, the consumer staples sector will be a safe haven — a sector that can ride out the storm with relatively little damage. But right now, expecting further outperformance from the staples group is a tall order and trying to use the sector as a shelter may backfire on the unwary.

Why? Well, consumer stocks may be a source of reliable, non-cyclical earnings, but this attribute is already more than factored into valuations. Standard & Poor’s projects large-cap staples companies to generate 8.7% earnings growth in 2013, behind the 9.2% growth for the broader large-cap universe. At the same time, the sector is trading at 15.9 times estimates — above the market P/E of 13.5 and tied for the highest of the ten major sectors.

Put these together, and consumer staples stocks are trading at a P/E-to-growth (PEG) ratio of 1.7 — 31% above the 1.3 PEG of the broader market. According to the S&P website, the stocks in the group “are trading near their highest P/E multiple in at least five years.” In terms of price-to-book, the Select Sector SPDR Consumer Staples ETF (NYSE:XLP) is trading at a huge premium to the broader market, at 3.5 versus 2.2.

Colgate Palmolive (NYSE:CL) is a prime example of a steady-Eddie stock that may deliver lower-than-expected returns due to its stretched valuation. Analysts see earnings growing 7.6% in 2013, but the stock is trading at a trailing P/E of 21.9 and a forward P/E of 17.6. The company is well-run and the stock offers a nice dividend of 2.3%, but how much further can it run with a PEG ratio of 1.97?

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Clorox (NYSE:CLX) is also among the names looking pricey here. Up over 12% year-to-date, CLX shares are trading at 19.3 trailing / 17.5 forward on estimated EPS growth of 5.9% in 2013. The company has been beating earning and raised its expectations for 2013 earlier in the month, but the stock is no bargain at this level.

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Valuation isn’t the only potential obstacle weighing on this group. Last week’s leaked memo that Walmart (NYSE:WMT) suffered its worst start for February sales in seven years could be a warning that the increase in the payroll tax from 4% to 6% is pinching lower-end consumers. The staples sector, by its very nature, is supposed to be a group that’s immune to economic turmoil. Still, a 2% pay cut is a direct hit to consumers’ bottom lines — and one that could prompt them to cut back, trade down or otherwise seek ways to save money. The sharp increase in gas prices is another potential headwind to consumer spending.

The Walmart case may be an isolated event, but it’s still one that raises questions about what first quarter earnings results in the sector are going to look like. Already, estimates for the largest consumer staples companies are starting to appear shaky. Among the top ten holdings in XLP, eight have seen estimates for the next quarter decline during the past 90 days, with only CVS Caremark (NYSE:CVS) and Altria (NYSE:MO) showing an increase. And seven companies have seen their 2014 consensus estimate fall, with only CVS, Altria, and Procter & Gamble (NYSE:PG) experiencing an increase. Investors will need to keep a close eye on this trend in the weeks ahead.

So far, the consumer staples sector performed as it’s supposed to: even as the S&P 500 fell 1.2% on Wednesday, XLP barely budged with a loss of just 0.2%. But given that the sector is already up over 9% year-to-date, it may be time for investors to temper their expectations.

As of this writing, Daniel Putnam did now own a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2013/02/consumer-staples-no-longer-a-sure-bet/.

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