Consumer Staples Sector

1
Consumer Staples Sector

• Industry Analysts
• David Gollinger, Theresa Ham
• J.P. LaFramboise,
• Derek Kuykendall, Addy Mittal

2
Recommendation

• Under-weight Consumer Staples
• Interim period between Federal Reserve action
• Under-weight 1.0, SP 500 is at 12
• Consider under-weighting more when the economy
  gains momentum
• Although there is uncertainty, the economy is
  expected to rebound, which would have a
  relatively negative effect on the consumer
  staples sector

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Outline

• Sector Overview
• Business Analysis
• Financial Analysis
• Valuation Analysis
• Recommendation

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Sector Overview
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SP 500 Composition
Source www.standardandpoors.com, as of 05/12/2003
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Consumer Staples Composition
Source Business Week Online,01/31/03.
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Consumer Staples Composition

• Anheuser Busch, 47.15 (Alcohol)
• Walgreens, 19.61 (Drug Store)
• Procter Gamble, 19.05 (Household Products)
• Altria Group, Inc., 14.19 (Tobacco)

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Business Analysis
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Demand

• Mature Life Cycle
• More Competition
• High Cash Flow
• Defensive Business Cycle
• Stable performer
• Performs better when market falls
• Performs better when dollar weakens

10

• Users and Geography
• High Foreign Exposure
• Global Franchises for BUD, MO and PG
• Declining dollar since the beginning of 2002
• Emerging markets in Asia and Latin America

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• Trend line analysis
• Given that consumer staples is a stable/defensive
  sector, we predict future demand to be consistent
  with past demand

12
Supply

• New capacity additions increase linearly with
  demand

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Financial Analysis
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Current Revenues are 60,375,000,000 Growth rate
is 6.7
15

• Revenues have a growth rate of 14.6
• Current growth rate estimate is 16.0
• Total returns have a growth rate of 21.8

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-Revenues have a growth rate of 4.0 -Current
growth rate estimate is 12.0 -Total returns have
a growth rate of 16.2
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-Revenues have a growth rate of 2.7 -Current
growth rate estimate is 9.00 -Total returns have
a growth rate of 11.0
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- Revenues have a growth rate of 3.5 - Current
growth rate estimate of 10.0 - Total Returns
growth rate of 15.1
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• Profit margins have risen from 14.2 in December
  2001 to 7.9 in September 2002.
• Profit margins have risen as revenues have
  fallen, indicating cost-cutting activity within
  the sector.
• Long-term estimated median growth rate is 11.2.

20
-Margins (EBIT/Sales) have fluctuated between
8.01 and 13.83 over the last decade. Margins
for 2002 were 10.02. -Asset turnover
(Sales/Assets) has fluctuated between 1.53 and
1.75 over the past decade. Turnover for 2002 was
1.64. -Reported ROE has fluctuated between 20.41
and 38.24 over the last decade. ROE for 2002
was 28.24.
21
-Margins for the SP 500 have been greater than
those for consumer staples, however, the ROE has
been less. Recall, ROE in 2002 for CS was
28.24. For the SP 500, ROE was 3.82 in 2002.
22
-Free cash flow after dividends has been positive
during the past 5 years -The sector had a
positive change in free cash flow during four of
the past five years.
23
Price of consumer staples has generally been less
relative to the SP 500. It declines in
expansion and grows in recession.
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Valuation Analysis
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Trends
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Dividends
() Dividends are providing a higher yield than
the SP 500
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Earnings
(-) Earnings are starting to dip as the economy
starts to look promising
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Earnings Estimates
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Value relative to SP 500
(-) P/E ratio is moving in the same direction as
price and earnings. Earnings are starting to dip
as well as the price, indicating that P/E will
not be expanding in the future
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Value relative to SP 500
Net profit margin is decreasing as the P/S ratio
decreases. Trend toward poor future performance
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Momentum
More selling activity than buying activity
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Total Return Estimates
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Valuation Summary

• Dividends, Dividend yield is higher than SP
  500 and trends toward remaining that way
• - Earnings, Earnings growth is not as high as SP
  500 and is slowing
• - P/E ratios are declining, it is a signal of bad
  things to come, not more value
• Overall, the total return is too low, and will be
  worse with a strengthening economy

34
Growth rate estimate has decreased to 10.9. The
estimate has not fallen as much as the rest of
the market, causing the upward trend line.
35
-Analysts have been recommending holding less
consumer staples over the past year.
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Recommendation

• Business
• Cycle indicates that the sector will under
  perform due to the state of the economy
• Financial
• Profit margins are increasing, revenues are
  decreasing, bad mix
• Valuation
• Poor returns for Consumer Staples expected

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Recommendation (contd.)

• Keep Consumer Staples under-weighted
• Economy is still trying to rebound from recession
• Consumer staples do not perform well coming out
  of recession
• Prices, earnings and net profit margins are
  trending downwards
• Estimate revisions and selling activity indicate
  skepticism about consumer staples future
  performance