Consumer staples reaching peak levels

When it comes to consumer staples, “we remain cautious,” says Foster Corwith, a portfolio manager with Causeway Capital Management in Los Angeles.

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These days, “we see businesses that [are] trading at peak valuations [and] near peak margin profiles,” adds Corwith, who manages the Renaissance Global Markets Fund. These businesses are also “dealing with changing business environments [due to] local competitors. With the growth of the Internet, smaller brands are able to reach the consumer and gain distribution.”

Larger consumer companies are well positioned for the longer term, he says, since they have great brands, and access to emerging market consumers and the growth of the middle class across the globe. But there will be challenges going forward.

Read: Tap into strength of U.S. consumers

Still, says Corwith, “a lot of people are looking for safety and defensiveness within consumer staples. The market has been willing to look beyond valuation to visibility and reliability in earnings profiles.”

The downside of that trend is the reach for yield. “Credit investors have been dipping their toes in equity markets [because] there’s no better place to start if you want reliability and yield in the consumer staples sector,” he explains. “As a result, you’ve seen valuations get pushed up. These businesses have been pushing up their payout yields for many years.”

A decade ago, says Corwith, the dividend payments of staples companies were sitting around 40%, versus around 60% today. “That starts to become unsustainable. We do question the valuation premiums [that] a lot of these businesses trade on. We see better opportunity in misunderstood businesses with more potential.”

Read: U.S. companies benefit when budgeting like Kraft Heinz

Most of the promising consumer companies are in the discretionary space, he notes. For example, “Advance Auto Parts is a great example of a very strong business [and] is one of three largest aftermarket auto suppliers, along with O’Reilly and AutoZone. [Advance is] a business that has margins that are half of where its peers generate, and it trades at a multiple [of] 30% to 40% below its peers.”

In addition, Advance’s CEO wants to re-engage the company. “It trades more or less in line with the S&P today. It has tremendous growth potential over the longer term. The profile of that growth [could] be as reliable as a staples business once restructuring is complete.”

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