Thursday, November 29, 2012

Is There Any Fizz Left in Beverage and Food Stocks?

Over the past few years, as the financial world has lurched from crisis to crisis, investors have found solace in the consumer staples stocks.

Investing in well-known companies like Coca-Cola and General Mills offers an appealing combination of attractive dividend yields as well as sustainable business models.  The world may turn ugly from time to time, but we are all going to eat and drink.

Yet, like all good stock ideas, there is a price at which investing in even safe companies can be less attractive.

So it would seem with the consumer products group, in my opinion.

As the chart above indicates, consumer staples stocks have been strong performers over the past 5 years.  While it has been a good ride for investors, in several cases it has driven the prices of the stocks to levels where one can question whether it might not be time to think about either trimming or exiting positions.

Trading at almost 19x price/earnings, the stocks in the consumer staples group can hardly be considered cheap.  When you compare the P/E ratios versus the relatively low growth rates of most of the stocks in the group, the relative valuation of staples companies does not look attractive.

Yesterday I went to hear Bryan Spillane, an analyst with Merrill Lynch who follows the Packaged Food, Beverages and Agribusiness stocks.

Bryan is a good analyst who has been following his stocks for about 15 years, and I have always found his comments interesting. He also welcomes tough questions, which is why I like to go hear his thoughts.

Bryan still rates a number of stocks in his coverage universe a "buy" yet I sensed a general lack of enthusiasm for the group.

His presentation material noted that most of the stocks he follows are trading at historically high valuations on a number of metrics.  In addition, when he talked about the strategic initiatives that company managements were proposing, I wasn't hearing anything that really made me feel that the high valuations were really justified.

So, after he had concluded his overview, I asked a somewhat impolite question:

"Bryan, from what I am hearing, most of the companies you are following are really not proposing anything new. Moreover, most of the management teams in place are the same ones that have presided over the slowing growth rates of the past couple of years."

"So, when you combine high valuations, and no apparent catalysts, are there any stocks in your group that get you truly excited?"

Bryan looked at me and smiled.

"My group will continue to do well so long as investors are willing to pay up for safety and dividend yield. While it is true that managements have been somewhat complacent over the past few years, I believe that there will be more pressure to produce meaningful improvement in returns."

"The other catalyst might be acquisitions.  My companies know they have to get growth rates higher, and they are largely flush with cash and unleveraged balance sheets.  The recent announcement that Conagra is acquiring RalCorp may be the first of several that we will see in the months ahead."

"Finally, while there is no doubt that companies like Pepsi and Coke are trading at relatively high multiples, a number of small companies (Dr. Pepper Snapple and Coca Cola Enterprises, for example) are still trading a low valuations relative to their growth rates."

"I would suggest focusing your attention on the smaller companies in my coverage universe as more attractive at this point in the cycle."

Good thoughts from Bryan, yet I am not totally convinced.