Morningstar Advisor - October/November 2009 - 61

Sector Rap Consumer Staples Hold Up in the Kitchen By Haywood Kelly As Americans eat more meals at home, packaged food and beverage companies benefit. With the U.S. economy mired in the longest recession in two generations, we thought we’d turn our attention to consumer staples stocks—a defensive area that should be holding up relatively well. We recently discussed consumer staples stocks with Erin Swanson and Philip Gorham, two of Morningstar’s consumer analysts. Haywood Kelly: Erin, everyone thinks of consumer staples and packaged food stocks as defensive. Have they lived up to that reputation during this recession? Erin Swanson: Yes, the defensive nature of these firms is shining through, as the sector outperformed the market by 7% and 22% in 2007 and 2008, respectively. Operating fundamentals justified this outperformance, as revenue and profitability at consumer staples and packaged food companies have held up much better than most industries. That said, with the economic outlook improving, the market is gaining ground, exceeding the consumers products’ sector return by 10% year to date. HK: Which of the companies you follow are performing best in this environment? Are any gaining market share? ES: As consumers eat more meals at home, primary beneficiary. While packaged food firms have seen some pressure on their branded offerings from private-label competition, retailers are still dependent on brands to drive traffic in their stores. Accordingly, dominant branded players have held their own in this market, while second- and thirdtier brands have struggled with retailers looking to consolidate vendors and reduce the number of brands on their shelves. General Mills GIS and Unilever UL are doing especially well due to their solid portfolio of leading brands. HK: Philip, what about the beverage companies you cover—is the recession having any meaningful impact on their businesses? Philip Gorham: Yes. Everybody needs to quench their thirst, but the recession is affecting the frequency and the location at which consumers are buying soft drinks. Consumers have cut back on their purchases of single-serve bottles at convenience stores, and they are looking to get more for their money in other channels such as grocery stores, where they can buy in bulk. This trend has been accelerated by consumers’ increased tendency to cook at home, as Erin mentioned. In response, beverage manufacturers are offering smaller and cheaper single-serve bottles in order to entice consumers at convenience stores. We’ve also noticed an abrupt halt in the growth of some categories that could be considered “luxury” products, such as energy drinks and bottled water, as consumers have been switching to cheaper alternatives. For example, tap water increased its share of all drinks consumed in the United States by almost 2 percentage points in 2008, while the share of bottled water declined by 1 percentage point. HK: How much are consumers trading down to private-label products? PG: With the exception of bottled water, where store-brand drinks have gained some traction, consumers have not switched to cheaper soft drink alternatives, and the market share of private-label has remained flat at around 10%. We think that there are two reasons for that: Customers are very loyal to their favorite beverage brands, and the leading manufacturers of branded drinks are adept at managing the price gap between their products and private-label alternatives in a way that dissuades the customer from trading down. ES: Branded packaged foods haven’t fared as well. Consumers are increasingly opting for private-label alternatives rather than branded goods, primarily due to the fact that private-label products cost on average packaged food companies have been the MorningstarAdvisor.com 61

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Morningstar Advisor - October/November 2009

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