The consumer will continue to power the economy -- but not quite so energetically as in the recent past. So investors will need to be more selective in shopping for consumer stocks. That's the lesson from Thomas Graves, head of Standard & Poor's Investment Advisory Services' group of analysts covering consumer-discretionary stocks. Nevertheless, he says S&P continues to recommend overweighting stocks in that sector. Among the trends Graves notes are consumers' tendency to concentrate more spending on their homes and their use of the Internet to comparison-shop.
One of the stocks in this sector S&P rated buy is Wal-Mart (WMT ), an outfit Graves sees as so efficient that it affects the value of its competitors, including supermarket chains such as Safeway (SWY ) and Albertson's (ABS ).
These were among the points Graves made in an investing chat presented Feb. 4 by BusinessWeek Online and Standard & Poor's on America Online, in responding to questions from the audience and from Jack Dierdorff of BW Online. Graves has no affiliation with or ownership interest in any company under discussion. S&P's other affiliates may provide services to the companies under discussion. Following are edited excerpts of this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Tom, what are we to make of this stock market? Will it go anywhere until the Iraq situation is resolved and the economic recovery seems certain?
A:Well, today we saw investors taking a cautious stance ahead of Secretary of State Powell's expected speech to the U.N. tomorrow morning. We do believe that the prospect of war is putting a cloud over the stock market, and greater clarity of what lies ahead will be important for creating sustained upward momentum.
Q: With consumer confidence down, are the consumer-discretionary stocks you cover still a good place to be?
A:We believe that there are still a good number of attractive stocks in our coverage area. Among our favorite stocks in the sector are Wal-Mart, Quiksilver (ZQK ), and Applebee's (APPB ).
Q: Can you give reasons for your stock picks?
A:We expect that Wal-Mart will benefit from consumers' continued price-sensitivity, whereby growing amounts of consumer spending will increasingly move from fuller-priced retailers to those who offer goods at more attractive prices. With Applebee's, we see a long-term demographic shift taking place, where consumers will be spending more of their eating-out dollars on full-service, sit-down restaurants. And Applebee's should benefit from this. With Quiksilver, we see this [clothing] company benefiting from its favorable appeal to younger consumers. Also, a sizable portion of Quiksilver's sales come from Europe. And recent weakness in the value of the dollar should enable these European sales to translate into stronger results.
Q: Can you clarify for us the difference between consumer discretionary and consumer staples, as S&P defines the sectors?
A:Consumer discretionary reflects industries wherein consumers are more easily able to defer their purchases -- such as clothing, travel, and even automobiles. In comparison, consumer staples reflects industries or purchases that are more central to everyday life, such as spending on food, beverages, and household products.
Q: Is consumer discretionary still a sector S&P recommends overweighting in a portfolio?
A:Yes, it is. We believe that there are enough attractive stocks to merit overweighting the sector. However, we do believe that there's not likely to be as much leadership in the economy from consumer spending in the year ahead as there has been in the last couple of years. We do believe that consumers will contribute to economic growth, but it has become increasingly important for investors to be selective in choosing stocks in this area.
Q: What's the better buy between Coke (KO ) and Pepsi (PEP )?
A:We prefer Pepsi to Coke, but we have a favorable opinion on both stocks. We have a buy opinion on PepsiCo and an accumulate opinion on Coke.
Q: You mentioned autos as a discretionary item -- is Ford (F ) a buy at these prices?
A:We advise holding shares of Ford, but we don't recommend new purchases.
Q: Is Home Depot (HD ) one of your consumer stocks? Is it a buy in the low 20s?
A:We do cover Home Depot, but we don't advise buying the shares. At current levels, we consider competitor Lowe's (LOW ) to be a more attractive stock. We do have a hold opinion on Home Depot, but we have some concern about recent weakness in same-store sales.
Q: How do you feel about Newell Rubbermaid (NWL )?
A:Newell Rubbermaid is one of our favorite consumer-discretionary stocks. We see a positive outlook for sales and profit margins, and we consider the stock to be attractive.
Q: What about the other extreme -- your least-favorite stocks, which investors should avoid or sell?
A:Among the consumer-discretionary stocks on which we have a sell recommendation are BJ's Wholesale Club (BJ ), Four Seasons Hotels (FS ), and CDW Computer Centers (CDWC ).
Q: Is there any common thread making trouble for these companies?
A:There are either company-specific or industry-specific reasons why we advise steering clear of these stocks. However, we do see certain themes that raise caution in our minds. For example, we have a relatively negative opinion on some of the hotel stocks that we cover because of concerns about the outlook for travel. As a result, we're advising people to either sell or avoid shares of Hilton Hotels (HLT ), Starwood Hotels (HOT ), as well as those of Four Seasons. However, our opinion is not the same on all hotel companies.
Q: How does S&P see the prospects for AOL? Will it go the way of WorldCom?
A:The shares have largely been beaten down by concerns about the health of its AOL Internet division. However, investors should keep in mind that AOL Time Warner (AOL ) owns a vast array of impressive assets, including leading positions in the film and entertainment industry. At current levels, we advise investors to hold the stock but don't recommend new purchases.
Q: What about the old-line department store chains? Some of them seem to be slipping.
A:We believe that there's a long-term shift under way in which department stores are losing market share to discounters and specialty retailers. Partly as a result of this, there are no department-store stocks among our buy recommendations in the consumer-discretionary sector.
Q: How do you feel about Circuit City (CC ) and Best Buy (BBY )?
A:Our advice is to avoid shares of both Circuit City and Best Buy. We're concerned that competitive levels will put pressure on profit margins and that there's risk of earnings disappointment in the year ahead.
Q: Tom, are there any new trends in consumer products that might affect stock value?
A:Some of the trends that we see occuring in the consumer-discretionary area are movement toward consumers staying closer to home and putting more of their dollars and time into where they live. Also, we believe that consumers have become increasingly price-sensitive and are shopping even more on the basis of price. In fact, the evolution of the Internet encourages this trend because it enables consumers to comparison-shop more readily than they could have in the past.
Q: Do you see problems with margins at Sears (S ), J.C. Penney (JCP ), and Target (TGT ) because of Wal-Mart?
A:We believe that Wal-Mart is likely to create margin pressue for nearly any company with which it competes in a big way. Wal-Mart is very good at operating efficiently and creating an environment that makes it more difficult for competitors to compete on the basis of price.... Of those three stocks, our favorite is J.C. Penney (JCP ), on which we have an accumulate opinion. Our advice on Sears (S ) and Target (TGT ) is to hold the shares but to not make new purchases.
Q: How about the big food retailers such as Safeway and Albertson's? Is Wal-Mart hurting them, too? Anything worth buying or accumulating?
A:We aren't especially bullish on the supermarket stocks. Wal-Mart is becoming a more formidable competitor in this area. More specifically, on Albertson's and Safeway we have hold opinions.
Q: So how about the drug chains such as CVS (CVS ), Rite Aid (RAD ), and Walgreen (WAG )?
A:We're bullish on shares of CVS, on which we have a buy opinion, and shares of Walgreen, on which we have an accumulate opinion. However, we do not have an analyst opinion on Rite Aid.
Q: Now for some fun -- what looks good in the entertainment business?
A:Entertainment, of course, can be viewed as a rather broad area. Some of our favorites among entertainment stocks: News Corp. (NWS ) and Fox Entertainment (FOX ), on which we have an accumulate opinion. Keep in mind that Fox is largely owned by News Corp.
Q: How about the movie business?'
A:The theatrical movie business in the U.S. had a strong year in 2002, helped by the popularity of such films as Spider-Man and sequels in the Harry Potter and Lord of the Rings series. However, much of consumers' spending on movies doesn't take place at the theaters. Home video is a much bigger outlet for consumer spending than movie tickets are. Also, it's important to remember that most of the companies that have leading market shares in the distribution of theatrical movies are also involved in other areas such as music, publishing, and television.
Q: On home movies, that's an area of great change because of DVDs and the potential for movies on demand. Any recommendations there? Steer clear of video stores?
A:Our feeling is that there will be a long-term movement toward consumers increasingly ordering movies and music from their homes and being able to bypass traditional retail stores. However, the video-retail industry has held up much better than people would have expected a decade ago, and we believe it's going to still take a significant amount of time to get the infrastructure in place for downloading of entertainment -- [too long a time] to cause a sharp drop in video-store activity.
Q: Do you have any sense of how war in Iraq might affect consumer spending?
A:I think we need to differentiate between the outbreak of war and the resolution of the war. An outbreak of war is likely to be at least a near-term negative on consumer spending. However, if there's a quick and favorable resolution, we believe that this would be helpful to consumer confidence and would help to bolster economic growth.
Q: It's getting to be time for you to sum up, Tom, so list your buys in the consumer-discretionary sector if you will.
A:We have 15 buy recommendations in the consumer-discretionary area. These are Applebee's, AutoZone (AZO ), Chico's FAS (CHS ), Clayton Homes (CMH ), Gannett (GCI ), Lear Corp. (LEA ), Lennar Corp. (LEN ), Mohawk Industries (MHK ), Newell Rubbermaind (NWL ), P.F. Chang's China Bistro (PFCB ), Quiksilver, SCP Pool (POOL ), Toys 'R' Us (TOY ), Wal-Mart, and Wendy's International (WEN ).
Edited by Jack Dierdorff