Just how contrarian are you? How to know when the onrushing herd has it right? When following Warren Buffett’s credo to be greedy when others are fearful, where’s the line between brave and foolhardy?
These are the self-directed questions of an investor today mulling Wall Street’s most-hated trade: owning the classic American consumer-staples stocks.
Exactly how much does Wall Street hate the packaged-food and household-products group? Let’s count the ways:
- The shares of Campbell Soup, General Mills, Kraft Heinz, Procter & Gamble, Colgate-Palmolive and Clorox are down between 17 and 30 percent year to date, compared with a slight gain for the S&P 500.
- Aside from Kraft Heinz, those stocks currently carry buy ratings from one-third or fewer of the analysts who cover them versus a bit more than 50 percent buys among all large-cap stocks.
- Goldman Sachs strategists calculate that hedge funds collectively have a bigger bet shorting the consumer-staples stocks than owning them.
- An already disliked group got another kick Friday with Campbell Soup’s lousy results accompanying the hasty departure of its CEO of seven years, Denise Morrison. She joins the former heads of Mondelez and General Mills in a gust of CEO turnover atop Big Food, a sign that the operating climate itself is forcing abrupt change.
While worse-positioned than most old-line food makers (heavily dependent on passe canned soup, and on condensed soup at that), Campbell is representative of the group’s difficulties: fraying loyalty among younger consumers for older brands and processed foods, rising commodity costs with little pricing power, and stiffer competition from retailer-controlled private-label products.
Michael Ramlet, founder of the market-research firm Morning Consult, told CNBC’s “Closing Bell” on Monday that the Campbell’s brand fell 22 positions in a consumer ranking among millennials compared with its standing with baby boomers and Generation X.
If those operating pressures weren’t bad enough, the stocks are a bad fit for the current market moment. A thrumming U.S. economy has more cyclically geared investments in fashion. Rising bond yields make the staples companies’ once-coveted dividend payouts less interesting.
Buy their way out of the slump?
Even the companies’ efforts to escape the trap of “tired 20th-century brand portfolio” through targeted acquisitions have failed to win over investors. General Mills has acquired Annie’s organic-snacks, Cascadian Farms organic products and Blue Buffalo pet foods, but it has so far gotten the company plenty of new debt without diverting investor attention away from its struggles in cereal and yogurt.
Acquisitions or mergers involving the staples companies themselves are a constant topic of wishful chatter on Wall Street. Yet there are only a few large, likely buyers such as Kraft Heinz, Nestle, Unilever and Danone, and none has been tempted yet. Because the U.S. staples companies generally have a fair amount of debt or are too large, private equity purchases are a stretch at current share-price levels.
Which leaves an investor with the conclusion that most of what there is to like about this sector is how hated it is. Plus the faith — shared by Buffett himself — that the decline in sales is not accelerating or permanent.
Esteemed deep-value hedge-fund investor Seth Klarman of Baupost Group has said, “Value investing is at its core the marriage of a contrarian streak and a calculator.”
The pervasive gloom surrounding the staples stocks, detailed above, shows that buying them here qualifies as contrarian. As for the calculator, some of the numbers are starting to fall into line.
Historically cheap valuations
The food stocks now all trade at steep discounts to both the broad market and their own history, based on current forecast profits — which, admittedly, have come down and might continue falling. The forward price/earnings ratios of Campbell, General Mills and Kellogg relative to the S&P 500 have not been as low as they are today for 15 to 18 years. P&G, Colgate and Clorox were last this cheap on a relative basis seven to nine years ago.
And while their dividend streams might no longer be the only game in town for income and will not do much to buffer further share-price declines, several of these stocks yield above 4 percent, on par with high-grade corporate bonds.
One reason investors seem so certain of the hopelessness of the staples’ business prospects is how wretched their stock performance has been over the past two years: Campbell cut in half, General Mills down 42 percent since the spring of 2016, in a market that’s up 30 percent.
Back then, of course, the market pushed these stocks to historically overvalued levels, in love with what they thought were their stable, defensive businesses, low volatility and reliable yields.
There is no saying the pantry-and-medicine-cabinet companies are cheap enough yet, even at half their P/Es of two years ago. But at some point and some price, they will require merely “less bad” news or one deal announcement or a sufficiently urgent strategic restructuring or a hint of stabilizing sales trends to start a recovery.
Probably the last group that was considered similarly uninvestable was the brick-and-mortar retailers last year, after Amazon’s purchase of Whole Foods.
The stocks went down relentlessly for months and seemed like perpetual value traps, before staging a fierce rebound — though not close to full recoveries of all losses.
And perhaps we’re seeing something similar now with General Electric — the poor corporate performance and ugly stock action came in so many waves and went so much further than most thought possible, that the negative case for the stock came to seem irresistible. GE shares are up 20 percent in the past several weeks — but are still down by half since a year ago.
Is that a comfort to the would-be contrarians in consumer-staples stocks — or a dire warning?
