Follow The Money Into These 3 Consumer Stocks to Buy

The consumer is back with multi-year-high confidence and strong spending numbers. Amazon is reporting its best holiday season ever and the National Retail Federation says total holiday spending could far exceed its initial estimate of $655 billion.

Expectations for 2017 have also grown, taking stocks along for the ride. Consumer confidence in November rose to its highest point since 2007 and sentiment among households earning $100,000 and more is at a 10-year high.

Keep in mind that this rising tide may not lift all boats equally. Recent government data supports this, showing uneven spending trends across categories.

Finding the best investments in retail, then, may depend on following the money in consumer trends while avoiding sectors facing a weaker outlook.

Not All Consumer Stocks Are Created Equal

Investors have high expectations for 2017 and recent economic data points to a stronger consumer next year. The labor market is approaching full employment with unemployment at just 4.6% and fiscal stimulus next year could mean even more hiring. Consumer spending has bounced this year on higher wage growth. A survey by Deloitte estimates holiday spending could be as much as 4% higher compared to last year.

Despite the stronger consumer overall, not all companies are facing an optimistic outlook. The Bureau of Labor Statistics’ consumer expenditure data signals a change in consumer trends.

Overall spending from 2008 to 2015 increased 23%, though spending on services jumped 25% while spending on non-durable goods rose only 17% over the period. Consumers also spent 23% more on big, one-time durable goods purchases.

Within the major categories, spending on some consumer electronics segments actually fell over the period. Some of this might be a function of lower prices on products while some might also signal lower volume. Either way, it’s not good news for consumer electronics companies.

These Companies May Be The Standout Consumer Winners

Two categories stand out in the data with over-sized gains in spending data: pharmaceuticals and pet-related spending.

Spending on our furry friends is split in two categories with 43.7% growth in veterinary services and 30.7% growth in pets and related products over the seven-year period. According to the American Pet Products Association (APPA), 65% of American households have a pet and industry-wide spending is estimated  $62.75 billion for 2016, 4% higher than the previous year.

Pharmaceuticals saw the highest increase in consumer spending across all categories, jumping 53%, or an annualized gain of 6.3%, over the period. Despite the headline risk and potential for regulatory oversight on pricing, the shift to an older population and universal healthcare is driving spending on drugs.

PetMed Express Inc (PETS) is the largest supplier of prescription medicines for pets and also provides non-prescription medications and supplies. PetMed is well-positioned for the shift in online retail with 80% of total sales booked online last year. The company has $52 million in balance sheet cash, nearly 11% of the market cap, and generates $10 million in free cash each quarter. With no long-term debt, the significant cash flow could boost the company’s 3.3% annual dividend yield and send the shares higher.

VCA Inc (WOOF) is the largest operator of full-service animal hospitals and veterinary diagnostic labs in the United States and handled more than 9.8 million patient visits in 2015. The APPA reports that pet owners spend approximately $16 billion a year on vet visits, more than 25% of total pet costs. Spending on veterinary and pet services, one of the fastest-growing segments, jumped 43% over the last seven years.

Operating margins in the company’s lab diagnostics business are extremely high at 40% and more than twice the 15% average margin at human diagnostic operations. Net income has grown by an annualized 13.6% over the last five years and the company generated $237 million in free cash last year.

AstraZeneca plc (ADR) (AZN) is a leading provider of branded drugs and has a strong pipeline of oncology drugs that should give it strong pricing power in the future. The company announced in August that it had received fast-track approval for phase 3 trials on its Alzheimer’s dementia drug, developed with partner Eli Lilly. Alzheimer’s is the most common form of dementia, accounting for up to 80% of cases, with worldwide costs estimated to reach $1 trillion by 2018.

AstraZeneca pays a 3.3% yield and generated $500 million in free cash over the last year. Fear over patent losses has weighed on the stock this year, leading to an 18% drop in the shares but the product pipeline is extremely promising and the 11.2 times earnings multiple is attractive.

Risks To Consider: Consumer spending trends are long-term changes and other factors will affect the investment thesis for companies even if overall trends help to support prices.

Action To Take: Ride strong consumer sentiment higher in the industries and companies benefiting most from changing spending trends by taking a position in beaten-down pharmaceuticals and pet-related companies.

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