Consumer spending has driven the U.S. economy for generations. It rose above 80 percent of U.S. output during the Great Depression as private investment and much of international trade dried up. It trended down a bit during the 1930s as the economy slowly recovered and then fell sharply during World War II as the nation imposed consumer rationing and switched its attention to making goods for the war effort. In 1944, consumer spending was only 49 percent of the gross domestic product.
No wonder, then, that people went on a major spending spree after the war. There was a lot of catching up to do. With a dip during the Korean War, consumer spending during the 1950s was in the low 60s as a percentage of the economy. It pretty much stayed there through the 1970s, rose into the middle 60s in the 1980s, and settled at about 67 percent during the last years of the 20th century. Consumers went on a major binge in the first decade of the 21st century. Fueled largely by debt, consumer spending rose to 70 percent of GDP and has edged even higher during the recession.
Looking ahead, here are some consumer stocks that seem to be poised to soar as we slowly emerge from the Great Recession. Our list was prepared by Standard & Poor's Equity Research. U.S. News asked S&P to look at the major spending categories and provide its top-rated stocks in each area. Here are the picks, with each company's trading or ticker symbol, its name, and its spending area:
|RL||Polo Ralph Lauren||Apparel|
|AAP||Advance Auto Parts||Automotive|
|MO||Altria Group||Consumer Goods|
|CHD||Church & Dwight||Consumer Goods|
|FDO||Family Dollar Stores||Consumer Goods|
|TUP||Tupperware Brands||Consumer Goods|
|SNI||Scripps Networks Interactive||Entertainment|
|TWC||Time Warner Cable||Entertainment|
|AHL||Aspen Insurance Hldg.||Financial Services|
|BAC||Bank of America||Financial Services|
|DFS||Discover Financial Svcs.||Financial Services|
|JPM||JPMorgan Chase & Co.||Financial Services|
|NYB||New York Community Bancorp||Financial Services|
|PRU||Prudential Financial||Financial Services|
|STT||State Street Corp.||Financial Services|
|TRV||Travelers Cos.||Financial Services|
|WSH||Willis Group Holdings||Financial Services|
|KO||Coca-Cola Co.||Food at home|
|GIS||Genl Mills||Food at home|
|WMT||Wal-Mart Stores||Food at home|
|DPZ||Domino's Pizza||Food away from home|
|RDY||Dr. Reddy's Labs||Healthcare|
|MHS||Medco Health Solutions||Healthcare|
|TEVA||Teva Pharma Indus||Healthcare|
S&P likes the world according to GARP. No, not the iconic John Irving novel but a research philosophy that seeks "growth at a reasonable price." S&P analysts are charged with determining a target price and an investment recommendation for each stock they cover. In aggregate, S&Ps highest-rated stocks have historically outperformed the S&P 500 on both an absolute and risk-adjusted basis. The compound average annualized price return of high-rated stocks from December 1987 through September 2009 is 12.77 percent, while that of the S&P 500 is 6.70 percent.
Here are capsule comments from S&P on its most highly recommended consumer stocks:
Chico's. Despite a renewed focus on merchandise flows and increased customer service, CHS customers have been reluctant to spend, and we project continued constraint in FY 2010 until the macroeconomic picture improves. While new executive appointments will likely take time to cohesively gel as a team, we already see improved catalogs and merchandise and a heightened color focus driving increased sales of Chico's Travelers line, which represented 40 percent of sales at its peak and currently is about 15 percent of brand sales.
Coach. We see favorable long-term sales and earnings prospects for COH, based as much on management's acumen as brand potential both domestically and abroad. In our view, COH has adeptly navigated the consumer pullback by lowering price points, increasing the value equation and developing new marketing strategies to appeal to a younger audience. We believe COH is in solid financial shape with $995 million in cash at September 30 and inventories down 16 percent from a year earlier, positioning the company for growth opportunities. COH's productivity and profitability metrics are double those of its specialty apparel peers, at an estimated $2,045 trailing 12-month sales per square foot and a 30 percent EBIT [earnings before interest and taxes] margin.
Polo Ralph Lauren. Geographic expansion, a more favorable merchandise mix, and strong brand positioning provide RL with attractive long-term growth opportunities, in our view. RL's assumption of direct control of its Southeast Asia (including China) business in January 2010 should provide substantial long-term growth opportunities with strong demographic underpinnings as RL seeks to grow this region to a third of sales, from an estimated $150 million. Near term, a cautious consumer, in both the affluent luxury and moderate channels, concerns us.
Under Armour. We regard UA as an early growth stage company in the highly competitive sports apparel and footwear market. Near term, we see its opportunities moderated by lower levels of disposable income, higher unemployment, inventory destocking at retailers, and its own curtailment of specialty store expansion in 2009, a prudent decision, in our view. Longer term, we see UA's strong and growing brand providing opportunities for new product adjacencies and expanding distribution and supporting above-industry growth. We see women's and international driving substantial sales and earnings growth when spending likely picks up in 2010.
Advance Auto Parts. We think several positive demographic trends will benefit the auto parts retail industry over the long term, most notably the increase in the average age of vehicles, driven by challenging economic conditions that have limited consumers' abilities to purchase new cars. In addition, we think the recent upturn in miles driven suggests consumers are shrugging off higher gasoline prices. This should lead to an increase in vehicle maintenance, given the significant pent-up demand that has accrued over the past few years. We think AAP's long-term initiatives to add additional commercial programs, change store formats, and identify opportunities to manage expenses will contribute positively to bottom-line growth.
Gentex. At 28 times our 2010 EPS [earnings per share] estimate, the shares recently traded at a sizable premium to the S&P MidCap 400 and a modest premium to peers after adjustments. We believe a premium is warranted based on our view of GNTX's ability to generate more consistent growth than peers.
Genuine Parts. Based on our 2010 EPS estimate, the stock's recent P/E [price-earnings ratio] of about 14.5 is below the average for peers, as depressed earnings for peers has increased the group average P/E. In normal economic conditions we think a premium for GPC is warranted by the company's greater earnings stability. We view GPC as financially strong. Earnings quality appears high to us, and an above-average dividend yield adds to GPC's total return potential.
Magna International. Based on our view of the company's stronger balance sheet and solid manufacturing capabilities, we believe that MGA's valuation should be higher than most of its peers. Following GM's decision not to sell a controlling interest in its Opel unit to Magna and partner Sberbank, we expect Magna to retire upcoming debt.
Altria Group. On June 22, President Obama signed the Family Smoking Prevention and Tobacco Control Act, granting the U.S. Food and Drug Administration the authority to regulate tobacco products. While we see this as a negative for the industry, it was well anticipated, and we see the restrictions solidifying market share leader Altria's dominant position and handicapping its smaller competitors. Operationally, we think Altria is likely to benefit from several factors over the next several years, including the integration of its recent acquisition of smokeless tobacco company UST and benefits from recent restructuring actions.
Family Dollar Stores. Our strong buy recommendation is based on valuation. We think that economic pressures such as higher gasoline prices have left core lower-income customers with fewer dollars to spend per store visit. However, we see opportunity for FDO to increase customers' shopping frequency and average transaction value with a broader selection of consumables, improved product adjacencies in stores, and expanded tender types and store hours. Longer term, we look for the company to focus on tailoring product assortments by store to drive higher sales productivity. We also view FDO's finances and balance sheet as healthy and expect the company to generate free cash that it can use, in part, for new store openings.
Tupperware Brands. We have a strong buy recommendation on shares of TUP, as we think the current price inadequately reflects improving underlying momentum in all five of its business segments and easier currency comparisons. We think TUP will benefit in the longer term from the 2005 acquisition of Sara Lee's direct sales business, which offers a higher growth profile and margin potential and should also help diversify TUP away from the historically more economically sensitive consumer durables housewares business.
Colgate-Palmolive. Our strong buy opinion reflects our view that CL's restructuring program is likely to help drive EPS growth near 10 percent from 2008 onward for at least several years. We expect the company to continue to invest in R&D and marketing, with more resources to be allocated to faster-growing markets. In addition, we have seen a smooth CEO transition, from Reuben Mark, CEO since 1984, to Ian Cook, formerly COO and himself a long-time CL employee, who became CEO on July 1, 2007.
Church & Dwight. We think the current valuation inadequately reflects what we see as the company's above-average earnings growth consistency and attractive growth prospects. We believe sales gains will be supported by international expansion, new product development, and added distribution. We think that CHD can draw cost savings from acquisitions, the implementation of enterprise resource planning systems, a full year of laundry detergent compaction, and a move to more efficient manufacturing.
Chevron. We have a positive outlook for CVX's upstream business, given its 2005 acquisition of Unocal and its ongoing international "Big Five" upstream development projects. We consider CVX's three-year reserve replacement rate as solid but below the peer average, and its three-year finding and development costs, proved acquisition costs, and reserve replacement costs as above peer averages.
ConocoPhillips. COP has been reshaping its upstream portfolio to focus on higher-growth assets. Reflecting weak markets, COP recorded asset impairments of $34.1 billion in the 2008 fourth quarter, including write-downs in its Lukoil investment. While COP had reduced its balance sheet debt, debt-to-capital ratios rose to 34 percent in the 2009 first half, reflecting the Origin Energy acquisition. In response, in October 2009, COP said it would sell about $10 billion of assets over the next two years and use proceeds to pay down debt.
Exxon Mobil. XOM has enjoyed a superior degree of earnings and dividend growth and stability (as evidenced by its S&P Quality Ranking of A+). We believe the company will benefit from "big-pocket" upstream growth opportunities in deep-water, liquefied natural gas, and ventures with state-owned oil companies. We think XOM's advanced technology permits project development in a timely and cost efficient manner. In addition, we see its upstream E&P [exploration and production] benefiting from a strong pipeline of long-lived resources and its downstream unit benefiting over the long term from its complex refineries, which offer feedstock flexibility and the processing of lower-cost feedstocks.
Activision Blizzard. We recently upgraded our recommendation to strong buy from hold, on valuation. Although we remain concerned about weak consumer spending, we think ATVI will outperform its peers because the company has some of the best-selling franchises, which we believe will sell well in a difficult environment. We think the company will benefit from continued growth of online gaming. Additionally, we expect the video game industry to recover in the second half of 2010, when manufacturers introduce new game consoles.
Gamestop. We think the video game industry continues to benefit from a growth cycle unprecedented in strength, and we expect near-term earnings growth from GME despite the slowdown in consumer spending. Long term, we believe the electronic game industry will benefit from hardware platform technology evolution, a growing used video game market, and broadening demographic appeal, but we have concerns that online gaming may take some share from the retail market. Nonetheless, we consider the shares' valuation to be compelling, with GME trading at about 9 times our FY 2011 EPS estimate, a significant discount to the S&P 500.
Time Warner Cable. We are somewhat concerned by relatively weak subscriber growth through the 2009 third quarter—evidently on the economic slowdown and competitive pressures—which TWC suggested continued into the fourth quarter. With a likely tradeoff on profitable unit growth, however, margins seem to be holding up. We see continued traction for the nascent commercial business—likely the next growth engine—with TWC also set for an imminent launch of its 4G wireless broadband product in several markets (under the Sprint/Clearwire joint venture). We see TWC on track for its near-term deleveraging goal of 3.25 times leverage ratio by March 2010—with likely free cash flow acceleration thereafter.
Scripps Networks Interactive. We view SNI's niche television networks positively, and we think they will garner attractive ratings and attention from advertisers. The focused content of SNI's networks should also generate consistent advertising from specialty retailers, which should help provide a baseline advertising level. In the near term, we see higher affiliate fees as SNI renegotiates key contracts, especially for the Food Network. We see the beleaguered Interactive Services segment improving modestly in 2010. SNI's networks may be an acquisition target, but we note this is unlikely before July 2010 as it would jeopardize the tax-free status of the SNI spinoff for SSP shareholders.
Aspen Insurance. Our strong buy recommendation reflects our view that AHL's valuation (on a price/earnings basis and a price/book basis) is at a discount to peers. We also view favorably steps AHL has taken to shore up its capital base and diversify its book of business. Still, we remain concerned that its exposure to catastrophe claims remains significant, relative to its capital base.
Bank of America. The Merrill Lynch acquisition is already adding to BAC's bottom line and should continue to do so. Charge-offs are apt to remain high, particularly in commercial loans. We look favorably on a deceleration of sequential charge-offs and nonperforming loans in the third quarter. Ultimate charge-off levels will likely hinge on unemployment rates and the success of loan modifications.
Discover. Managed receivables growth will likely increase in FY 2009, due to the addition of Diners Club, higher merchant acceptance, and a slowdown in customer payments. Although we see charge-offs picking up due to higher unemployment levels, we think DFS's should be lower than most of its peers given its more conservative customer base and lower market share in areas in which housing prices are under great pressure. Based on a slowdown in charge-off growth, we think the stock will eventually trade near its historical 1.8 times multiple of tangible book value (TBV).
JPMorgan Chase. Although we think JPM is well reserved for tough credit conditions, rising charge-offs will likely continue at least through the fourth quarter of 2009. At that point, we expect provision building to ease, which should translate into higher EPS. JPM has already paid back government TARP capital of $25 billion, which should give it an advantage over competition due to lower restrictions regarding compensation and the ability to take higher risk. We think JPM's exposure to additional securities write-downs is limited. We see a decline in provisions in relation to charge-offs as the next potential catalyst for the shares. Notably, sequential charge-offs rose at a slower rate in third quarter, signaling, in our view, a possible end to further deterioration in JPM's loan portfolio.
New York Community Bancorp. We believe the AmTrust acquisition will be immediately accretive and will create a platform for future deposit growth in new markets. In addition, we forecast minimal loan losses as a result of the loss-sharing agreement with the government. We think the largest part of NYB's loan portfolio, on rent-controlled multifamily properties (roughly 72 percent of total loans as of the end of the third quarter), will hold up relatively well in recessionary conditions. While we expect losses to be above NYB's historical average, we believe the company's credit quality will continue to be much better than peers.
Prudential. Our strong buy recommendation is based on our view of PRU's collection of high-growth businesses and its superior financial flexibility. We believe PRU will expand earnings and return on equity at a faster rate than many of its peers and is well positioned to gain market share in many product areas. We expect PRU's strong financial position will allow it to deploy a considerable amount of excess capital in the credit markets, and the company could potentially execute a sizable acquisition in 2010. We believe PRU's stock warrants a higher valuation versus many peers due to its broad business mix, distribution capabilities, and its rapidly growing international division, which will benefit from a favorable competitive landscape in Asia, in our view.
State Street. STT has recently addressed our major concern—low capital levels—with a roughly $1.5 billion public equity offering. It also recently moved $22.7 billion of its conduits from off-balance sheet onto its balance sheet, removing another overhang on the stock, in our view. After the capital raise, its tangible common equity ratio now totals 5.7 percent and should improve further in the coming quarters based on profitability, by our analysis. We find further comfort that the government's stress test determined the company does not need to raise capital, even under an adverse economic scenario. With our view that most of STT's major risks have been removed, we look for its trading multiple to expand closer to historical levels of roughly 17.5X forward 12-month estimated earnings.
Travelers. Although our outlook remains tempered by concerns we have that both the underwriting and investment environments will remain challenging in 2009, we believe TRV's shares do not adequately reflect the actions the company has taken in recent years to improve its underwriting results and to better capitalize on what we see as a flight to quality within the property-casualty insurance market. We also view TRV as a prudent underwriter with an above-average quality balance sheet.
Willis Group Holdings. WSH has maintained industry-leading operating margins and organic revenue growth over the past year amid a soft pricing environment. The company has more than offset pricing pressure by winning new business and maintaining strong retention rates. We look for property and casualty pricing to improve in 2010, which should provide a boost to WSH's organic growth rate, particularly in the United States. We believe its Shaping Our Future initiatives remain on track, and we expect WSH to exceed its financial goals by 2010. We see significant synergies from the HRH acquisition, and we think the company should significantly improve its position in the U.S. middle-market business. With the stock trading at a discount to peers, we view WSH's valuation as compelling.
FOOD AT HOME
Coca-Cola. We look for volumes in KO's noncarbonated portfolio to continue to be healthy, as the company widens distribution and as premium pricing has held. We view KO's long-term growth targets as reasonable, particularly in light of its high exposure to international markets, which should offset low single-digit volume declines at the Coke brand in the United States. On increasing trial and awareness, we see Coca-Cola Zero driving trademark Coca-Cola volumes worldwide. We think a weakening of the dollar could provide a further boost to profits.
General Mills. We expect GIS's important U.S. Retail segment to benefit from consumers eating more at home. Also, we generally like the company's brand strength, which we think will provide some protection from competitive pressure presented by less expensive private label products. We believe that GIS has opportunities to bolster longer-term profit margins through a focus on such areas as manufacturing and spending efficiency, global sourcing, and sales mix. We look for GIS to continue generating free cash flow, with a portion being used for dividends and stock repurchases.
Wal-Mart. We believe the company is well positioned to gain market share in an adverse economic environment, as we think consumers will continue to trade down from higher-cost competitors and take advantage of its one-stop shopping convenience. We believe WMT's significant staples product offerings and basics discretionary offerings position it well despite weak consumer spending.
FOOD AWAY FROM HOME
Domino's Pizza. Our strong buy recommendation reflects our view that 2009 reductions in debt outstanding, coupled with some stabilization in operating results, have begun to mitigate the financial risk from DPZ's highly leveraged capital structure. We also are more confident in the long-term success of recent menu additions, as well as DPZ's decision in late 2008 to lower prices on a substantial part of its menu and rely less on promotions.
Dr. Reddy's Labs. We view RDY as one of the stronger growth stories in the global generics space. We think the company has revitalized its generic pipeline, which includes about 67 ANDAs [abbreviated new drug applications], of which 16 represent potentially lucrative first-to-file marketing exclusivity opportunities. We also believe RDY has strengthened its geographic reach in Russia and other emerging markets and has achieved diversification in the generic biotechnology space. We expect generic biologics to contribute importantly to future growth. We also view RDY as a possible takeover in the consolidating global pharmaceutical industry.
Edwards Lifesciences. We think EW's core surgical valve and valve repair businesses are relatively defensive and largely recession-resistant product lines that should continue to post solid results despite the current economic weakness. We see TCVs as one of the emerging opportunities in the medical device space and believe that EW has a substantial time-to-market advantage for U.S. introduction of TCVs (expected in 2011) over its main competitor. In our opinion, Edwards is also one of the more logical takeover targets in the medical equipment group.
Express Scripts. We are encouraged by ESRX's acquisition of NextRx, which should boost its claims volumes by 50 percent and, we believe, improve its clout with drug makers and its competitive position. Before transaction costs and intangibles amortization, ESRX sees the deal as accretive from the start and, upon 12-18 months integration, adding over $1 billion to EBITDA [earnings before interest, taxes, depreciation, and amortization]. Moreover, we think a strong generic drug launch cycle we see through 2015 and opportunities presented by healthcare reform, should it occur, provide healthy long-term earnings growth for PBMs [pharmacy benefit managers], including ESRX. Meanwhile, we are also encouraged that ESRX has been experiencing a strong selling season, winning 238 accounts for 2010, including eight major ones, as of September 30.
Medco Health Solutions. We view the fundamentals of the PBM space as bright, as health plans, governments, and employers seek to control drug costs. We believe the weak economy will continue to pressure drug utilization but spur increasing generic drug and mail utilization, which saves consumers money while benefiting PBM margins. Looking ahead, we believe MHS has significant opportunities to expand generic drug mail penetration of its new 2009 accounts, and we expect the company and peers to benefit from pending patent losses of additional brand-name drugs. We also view certain healthcare reform proposals, including an approval pathway for biogenerics, as providing opportunities for PBMs. Elsewhere, we view MHS's cash flow as healthy, providing financial flexibility.
Mylan. We believe MYL's efforts to expand its base through the acquisitions of Merck KGaA's generic business and Matrix Laboratories hold much long-term promise. Besides broadening MYL's geographic reach, these deals also provided access to in-house sourcing of active pharmaceutical ingredients and generic biologics. MYL also recently formed a venture with India's Biocon to develop biogenerics. We expect accrued merger synergies to exceed $300 million by the end of 2010. We also think MYL is well positioned to benefit from the robust growth that we project for the generics market.
Teva. We see demand for generic drugs continuing to advance as countries worldwide seek to limit the rise in drug spending, particularly in light of the soft global economy. With the largest generic drug portfolio among peers and some 210 ANDAs awaiting FDA clearance, we think Teva will continue to gain market share by offering one-stop shopping. Meanwhile, we also see Barr strengthening Teva's presence in the United States and Central and Eastern Europe, and in women's health and biogenerics. Elsewhere, we are encouraged by its pending penetration of Japan. We also believe Teva is well positioned to benefit from anticipated congressional enactment of a new regulatory pathway for generic equivalents for biological drugs.
Lennar Corp. After $4.4 billion of asset impairments since the beginning of 2006, we believe write-offs will continue, albeit at a lower level, in FY 2009. We think LEN's joint venture with Morgan Stanley (formed in December 2007), whereby that firm paid $525 million to LEN for an 80 percent equity stake in acquired land, was beneficial to the company. As of August 31, 2009, LEN had $1.34 billion in cash to support its working capital and debt obligations.
Meritage Homes. Meritage's reliance on weak regional territories mainly in the Southwest hurt the company's past performance, but it has recently made adjustments by concentrating more of its home building in the stronger Texas market, where it is a leading builder. Currently, two thirds of the company's revenue comes from Texas, and we believe MTH will benefit from the state's more stable economy and lower unemployment.
Toll Brothers. We believe the housing market is beginning to recover, with a stronger outlook for 2010. We think TOL stands to benefit from its business model focusing on high-end homes, a strong balance sheet, and capable management. We see TOL gaining market share from private luxury builders in FY 2010, and we think it has ample cash to acquire land for future growth.
USG Corp. We think government stimulus will allow USG's depressed business to bottom in coming periods, and also think it has solid long-term prospects. Moreover, we think USG's sale of $700 million of notes since late 2008 (in two separate transactions) firmed up the balance sheet, and amendment of its credit facility in early 2009 greatly eased its covenants.
FPL Group. We believe the shares will benefit from the expansion of FPL's wind and solar power projects and from the tax credits provided by the passage of the federal stimulus package, which could add 10 cents to 15 cents to annual EPS over the next several years. While the stock has been restricted by the uncertainty related to FP&L's rate increase request, as well as the continuing weakness in the Florida economy and housing market, we believe the shares will benefit from the growth prospects we still see for NextEra Energy Resources, with above-average total return over the next 12 months.
ONEOK. We believe OKE's controlling ownership of OKS will allow it to focus on growth activities at OKS, while the company should continue to benefit from solid cash flow from utility operations, OKS partnership distributions, and general partnership incentive payments. We expect much lower commodity prices in 2009 compared with 2008, but we see significant long-term value in ownership of OKS. Should the U.S. dollar weaken further, we think substantial upward pressure on oil prices would result, benefiting OKS's gathering and processing segment.