6 U.S. Food, Beverage And Tobacco Stocks: Defensive Plays Amidst Current Turmoil

Consumer stocks are often seen as a refuge during difficult economic times. Consumer stocks keep on making money as consumers smoke cigarettes from Pall Mall (British American Tobacco (BTI)), soft drinks from Coca Cola (KO), and other common items from a wide variety of companies that investors see as consumer stocks.

Long term investing in consumer stocks is a conservative approach to stock investing. Many of these are dividend stocks that have paid quarterly dividends without fail for decades. These companies will typically not grow in multiples but can commonly provide the investor with a healthy rate of return, a combination of stock price appreciation and dividends. Consumer stocks are commonly part of a balanced stock portfolio. They are often seen as good retirement stocks. However, these stocks do go up and down in price.

When a recession threatens, traders and investors buy these stocks and their price goes up. When a recovery is on the horizon, traders often sell these stocks and get back into growth stocks and consumer stock prices go down. Of course, the basic stock fundamentals also apply.

What's different this time vs. the last recession?

Now as then, investors are worrying about a 2009-styled economic meltdown given the persisting events in terms of sovereign debt problems, governments’ austerity spree, stubbornly high unemployment rates and funding problems in the financial sector.

1. Inventory levels

In 2008/2009, the rapid economic downturn took most companies by surprise. As a result, firms significantly cut inventories in view of the great uncertainty. ’De-stocking’ was then the key reason cited by consumer companies for declining sales. This time around, inventory levels are more balanced, both at a company level as in the retail/wholesale channel. Consequently, sales and earnings should come in more stable than in the last cycle.

2. Exposure to Emerging Markets (EM)

The 2008/2009 crisis has helped to push the structural (consumer) strength in emerging markets to the fore. The most important thing that consumer companies have been doing since then is to reallocate capital and human resources to EM. Three years on, EM now account for about 35% of total sales in the sector, up from roughly 28% in 1H08. Driven by the pursuit of growth, companies are expected to continue to dedicate more resources to emerging countries. In the current cycle characterized by bleak economic prospects in the developed markets (DM) and resilience in EM, business weakness in DM should be offset by growth dynamics in EM.

3. Product/price strategy adjusted

In the pre-recession period, consumer companies relied heavily on product ‘premiumization’ (= trade-up) in Western countries. Currently, however, the barbell-shaped consumer income pattern has resulted in a barbell-shaped consumer spending pattern with high-end and low-end segments growth at the expense of the mid-market segments The after-recession new consumer pattern in DM, in the US in particular, has fundamentally changed the way companies develop and sell their products. Consumer companies have already embarked on adjusting their business models to the new reality of a distinctly different market growth environment.

4. Retail diversification

Compared to the pre-crisis era, a multi-channel retail world has now been taking shape. Online retail channels have gained significant strength. In addition, companies have been changing the way they sell products in order to cope with the increasing popularity of social networks and tablets. In terms of bricks-and-mortar retailing, the trend is clearly favorable to smaller stores and convenience stores, driven by an aging population, a smaller household size, high gasoline prices and increasing pressure on shopping time, while the big-box stores seem to be at a disadvantage.

5. Financial strength

Moreover, companies have de-leveraged over the past three years, and are now in a financially more comfortable situation. The stress on the bond markets should have less impact on Food, Beverage & Tobacco. In the longer term, sales growth for this sub-sector, for food and beverages in particular, is driven by global population growth, by rising living standards in the EM and by product mix improvement. In the current cycle, the first two core drivers remain fully in tact. It is only the ’product mix’, or the trading-up element, that is challenging. The bigger short-term risk for the sector has been input cost inflation. But the industry has proven itself adept at withstanding inflation.

As Q2 results showed, almost every company beat expectations on prices. It looks that the industry has largely got through pricing. On the other hand, raw material costs have been modestly down over the last 3-6 months, taking off some of the input cost pressure. The net effect should be margin improvement.

In the table below you find 6 US-listed stocks in the Food, Beverage & Tobacco sector that can face the headwinds and are a defensive play in the current turmoil.