COMPANIES THAT MAKE
or sell consumer staples are a natural investment choice when the economy slows down. It turns out they can also be organic, particularly if you're looking for small stocks.
Thanks to the growth of the natural foods movement, consumer staples are no longer just the domain of conglomerates like Procter & Gamble and Kimberly-Clark.
Hain Celestial Group, for instance, is a $1.1 billion company with a bevy of household brands including Celestial Seasonings teas, Arrowhead Mills baking mixes and Health Valley snacks. It also owns the Earth's Best organic baby food line, the Rice Dream and Soy Dream "milk" brands, and some gourmet-minded frozen foods and natural hygiene product lines. Then there is United Natural Foods, a $770 million company and the largest wholesale distributor of natural products to grocery stores. Its biggest customer is Whole Foods Market.
Wall Street considers the consumer staples business relatively insulated from recession because even if money is tight people still need to buy things like cereal and soap. In the past four recessions, this has proven true, with stocks in the consumer staples sector outperforming other areas of the market, according to Citigroup small-cap and midcap equity strategist Lori Calvasina.
The added benefit of small companies such as Hain and United Natural is that they're also growth stocks and market leaders in a niche industry. Analysts are forecasting annual earnings growth of roughly 15% for each company over the next few years, according to Thomson Financial.
"The natural and organic foods industry is broadening and becoming more mainstream," says Philip Tasho, manager of the Aston/TAMO Small Cap Fund, which owns Hain shares. "Overall consumer spending may decline, but consumers aren't going to scrimp on products for their health."
Both Hain and United Natural's stocks have taken hits lately and look reasonably priced compared to larger, slower-growing consumer staples companies.
United Natural's shares are trading at 13 times expected annual earnings after falling 25% since the company reported weak quarterly earnings last week. Investors are spooked because the Dayville, Conn., company missed analysts' expectations by a good nine cents per share. But the selloff looks short-sighted; most of the miss is from a new distribution business United Natural acquired in November that is proving costlier to integrate than expected but should help grow its customer base once the dust settles. With the acquisition, revenue rose 24% including an 81% increase in sales to supermarkets. Without the acquisition, growth in United Natural's core business was still solid, with revenue up 13% at $758 million.
Hain's shares, meanwhile, are weak amid worries about rising commodity costs, with the stock 20% off its last peak in October 2007. In its latest quarter, Hain's revenue was up a strong 20% but there was some pressure on margins. The stock is trading at 20 times expected earnings for its fiscal year ending in June. Although that's not overly cheap, compared to other food companies it's within reason considering Hain's double-digit growth prospects. General Mills and Kellogg, for instance, trade at about 17 times expected earnings but are projected to grow less than 10% over the next few years.
"Hain offers investors an attractive combination of growth and relative economic insensitivity that we believe is an appealing combination in the current market environment," Canaccord Adams analyst Scott Van Winkle said in a research note on Feb. 5.
The downside to Hain and United Natural is that, being small companies, they do depend to a degree on just a few customers, including each other. Hain's biggest customer is United Natural, which accounts for about 20% of sales. For United Natural, Whole Foods accounts for about 28% of sales and that will increase to nearly 40% as Whole Foods integrates its acquisition of the Wild Oats chain. In addition, both Hain and United Natural are growing through acquisitions and integrating their new businesses will soak up resources, as United Natural's last quarter shows.
Still, these are companies growing in an otherwise mature business because they've found a new niche, just as Whole Foods is bringing new life to the sluggish grocery store business. If they stay on track, buying the stocks at current levels is a healthy bet.