Consumer Staples Look Ready to Catch Up

 | Jan 03, 2014 | 1:00 PM EST
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Consumer staples stocks started 2013 on a tear, with an almost 20% gain in the first four months of the year. After that strong start, the performance was very mediocre from May to December. The group was up by mid-single digits over that period, compared with the S&P 500's gain in the low 20s.  

These stocks drifted modestly higher as the market roared ahead. Their relative weakness was driven by a rotation out of near certainty and into more economically sensitive areas of the economy. They were also hurt as the love affair with higher-yielding stocks temporarily came to a halt.

We believe this period will have been a pause that refreshes, and we look for consumer staples stocks to play catch-up in 2014.

As we look to 2014, we expect a healthy and improving economy, but look for more modest stock market returns and far more volatility compared with 2013. In that environment, yield and stability should have a very positive influence on portfolios. As such, we believe that now is a good time to revisit and expand one's exposure in this area.

Four stocks that we like are Coca-Cola (KO), PepsiCo (PEP), Procter & Gamble (PG) and Kellogg (K).

Coca-Cola should be a steady performer in 2014 as the company continues to benefit from robust growth within the emerging-market economies and improving North American and European developed operations. It should generate respectable revenue and earnings growth of 5% to 8% for the year. Margins should do even better after a new round of restructuring initiatives. The shares are reasonably priced and trade in line with the company's long-term valuation levels at 18.4x 2014's EPS estimates of $2.25. The company continues to repurchase shares and pays a 3% dividend yield. Coca-Cola should provide both stability and growth to investors in the upcoming year.

PepsiCo is also expected to show solid results in 2014. The company is just beginning to see the benefits of the major repositioning and cost-reduction programs it has enacted over the past 18 months. Savings from the multi-billion-dollar cost-cutting programs are only now falling to the bottom line, while new advertising investments are just beginning to show traction. Revenue should rise 5% to 6%, while earnings should see an 8% to 9% increase. The shares are reasonably priced, trading slightly below the company's long-term valuation levels at 17.8x 2014's EPS estimates of $4.65. The company continues to repurchase its shares and has a healthy 2.8% dividend yield, which we expect to increase over time. PepsiCo shares should be a Steady Eddie for 2014.

Procter & Gamble should also show steady gains for 2014 and even some more upside to the numbers. With the return of A.G. Lafley as CEO in 2013, Procter & Gamble is setting the stage for a rebound in its long-term growth rate after several disappointing years under the prior CEO. Lafley has set a new tone for reducing costs and executing on top-line growth. To date, the numbers have improved every quarter. 2014 should be an even better year. The shares are reasonably valued and trade in line with the company's long-term valuation levels at 19x 2014's EPS estimates of $4.30. The company continues to aggressively repurchase shares and pays a 3% dividend yield. Of the four stocks in today's discussion, we think this one has the most upside to the numbers -- its valuation and stock price -- in the upcoming year.  

Our last recommendation is Kellogg. The shares have been relatively flat and disappointing for 2013 as the earnings estimates came in modestly below expectations. However, at 15.1x 2014's earnings estimates of $4.05, and with a 3% dividend yield, Kellogg should be a low-risk and profitable holding for investors in the upcoming year as management implements incremental cost-cutting programs and grain prices show moderate declines. 

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