Consumer-staple stocks, known for their stability, have taken a hit in 2023. Despite this downturn, prices haven't dropped enough to entice bargain hunters.
In the previous year, consumer staples proved their worth as a safe investment during market downturns. However, things have changed drastically this year. The market's 2023 rally, driven by risk-taking, has left investors uninterested in reliable consumer stocks. Even the ever-growing Big Tech has stolen the spotlight as a defensive safe haven during banking concerns this spring.
Not only that but the increase in interest rates has made their once juicy dividends less attractive. Concerns about weight-loss drugs lowering long-term demand for food and beverages have added to investors' worries. Moreover, brands are experiencing a natural decline from the pandemic-induced boom, as people start consuming less at home.
As a result, while the S&P 500 has seen a 13% rally year-to-date, the Consumer Staples Select Sector SPDR exchange-traded fund (XLP) has fallen approximately 9%. However, even with this decline, the valuations of these stocks fail to entice investors, making it challenging to enter the sector except for a few select names.
This has left consumer staples in a state of ambiguity, unsure of what will drive their prospects in the near future. Wells Fargo analyst Chris Carey aptly describes the current situation as a transition from "staple-topia" to "staple-dystopia."
"In 2022, we witnessed the best year for consumer staples compared to the market in decades. However, transitioning into 2023 was always going to be challenging, and it became evident during the summer," writes Carey in a recent note. "But what we've witnessed lately, in terms of rates, volume, GLP-1, and more, has been astounding. The problem is, we are unlikely to see the necessary fundamentals improve in the third quarter (volumes), and while valuations are better, they are not remarkably cheap."
Carey highlights that exchange rates remain a concern for multinational players, while higher prices continue to negatively impact volumes as consumers, worn out by inflation, naturally limit their spending.
Additionally, while some investors have shifted their focus from food and beverage companies to home and personal-care brands due to concerns about Ozempic, these stocks now carry relatively higher valuations.
The "Great Reset" in Staples
The performance of Staples in the market has undergone a significant shift, which has come to be known as the "great reset," according to industry expert Carey. While Staples had a remarkable year compared to the market in 2022, it has been underperforming so far this year and is on track to have its worst year compared to the market in at least two decades, even worse than in 2003.
This assessment is shared by others in the industry. Filippo Falorni, from Citi Research, highlights the mounting pressures on consumers in the United States due to persistent inflation, rising interest rates, and the resumption of student-loan repayments. For Consumer Staples companies, the pressures on consumers are further compounded by a strengthening U.S. dollar, rising oil prices, and higher borrowing costs.
As third-quarter-earnings season approaches, early reports from consumer-staples companies have been mixed at best.
Investors may need to exercise patience and weather some of the negativity. Bernstein analyst Ivan Holman believes that concerns about weight-loss drugs may be exaggerated but still acknowledges the need to adjust outlooks on stocks given the market's tendency to remain irrational for extended periods. It's not necessary to take unnecessary risks.
However, there may still be some winners in the sector. According to Carey, investors can find strength and promising prospects in Church & Dwight (CHD) and Procter & Gamble (PG), as these companies seem to be heading in the right direction in terms of fundamentals. While many others are still working towards normalizing their fundamentals, these two companies stand out.
Additionally, Keurig Dr Pepper stock (KDP) could be undervalued considering the improvement of its coffee business and the ongoing momentum in cold beverages.
All three companies will be reporting their results in the coming weeks. So sit back, relax, and enjoy the show.
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