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Best Of Breed: Three Consumer Staple Plays With An Edge


Companies at the top of their game.


Consumer Staples? Really? I know what you're thinking. One word: boring. "Look, man, we're interested in trading stocks, not hanging wallpaper. Give us something that moves, like a (BIDU), an Apple (AAPL) or Research in Motion (RIMM)."

Fair enough. Those stocks are indeed volatile. But just as fruit goes in and out of season at the produce stand, so too do stocks.

Have you ever stopped to consider for a moment how many Consumer Staples products you used this morning? Did you shave, take a shower, have breakfast, with maybe coffee, orange juice, milk? Did you blow your nose? Use a napkin to wife coffee off your keyboard? Take an aspirin, blood pressure medication or anxiety drug? These products are everywhere.

On the surface Consumer Staples may seem like a boring sector, but there's nothing at all boring about the cost of your raw materials going up in 30-40% chunks in a single quarter. There's nothing boring about being among the few companies with the ability to pass through much of that cost to consumers. And when raw materials prices come down, and they will, there will be absolutely nothing boring about retaining that pricing and seeing your margins expand.

Year-over-year, Consumer Staples based on the Consumer Staples Select SPDR Fund (XLP) are up 2.5%. The S&P 500 is down 7.6%. Year-to-date the XLP is off 2.7%, but that is better than the S&P 500s performance, off 4.8%.

Top 10 Components of the XLP Weighting

  • Procter & Gamble (PG) 16%
  • Wal-Mart (WMT) 10.7%
  • Philip Morris International (PM) 8.7%
  • CVS Caremark (CVS) 5.2%
  • Coca-Cola (KO) 5.2%
  • PepsiCo (PEP) 4.3%
  • Kraft (KFT) 3.8%
  • Altria (MO) 3.5%
  • Colgate-Palmolive (CL) 3.1%
  • Anheuser-Busch (BUD) 3.1%

The XLP is certainly one way to play the Consumer Staples sector, but when we look at the components above we see the fund is heavily weighted in just two companies, PG and WMT.

So which of the Consumer Staples are "Best of Breed"? And, by the way, what does "Best of Breed" mean anyway?

Best of Breed, of course, is the title given to dogs judged to be the best representative of their particular breed at a dog show.

For stocks, however, judging Best of Breed is a bit more complex. Some use it in a simplistic manner to point out the most recognizable company among peers, or the company with the best branding. For example, in a simplistic way Best Buy (BBY) might be considered Best of Breed compared to Circuit City (CC) or Radio Shack (RSH). It is certainly the most recognizable of the three companies.

But does recognition and branding make it a Best of Breed stock? If only it were that easy. BBY is down 17% year-to-date. RSH is down 14%. CC is up 19%.

Below are three stocks in the Consumer Staples sector I consider Best of Breed. Sure, recognition and branding has something to do with it, but what I also want to see, say, for foods companies is pricing power to fight off rising raw materials costs and a diversified product mix between premium and private label products. For household products companies a strong pipeline of product development and ability to retain market share while pricing for raw materials increases. But more than anything else, I want to see an edge.

Darling International (DAR) Ever heard of them? Maybe not. They provide something very simple and necessary though. They turn animal and food wast products - unused skin, fat, bones and brains that they get from slaughterhouses and restaurants - into useful commercial goods they can sell, such as tallow, protein meals, grease, glue and (man up and listen to this part) fuel. It's a dirty job, but somebody's gotta do it. What's their edge? They are the largest, and the only publicly-traded, rendering and recovery specialist.

Performance, year-over-year: +86%
Performance, year-to-date: +29%

General Mills (GIS) You no doubt have General Mills products in your cabinet. And even if you think you don't, you probably do. Because the company also makes unbranded food products for food service and commercial baking industries. This is not a sexy business.

So where's the General Mills edge? They've been one of the few Consumer Staples food-related companies to grow margins in spite of rising raw materials costs. As of last quarter GIS reported year-to-date sales volume up 3%, net sales up 8% and even U.S. retail sales up 6% overall with growth in every division. What's their edge? They are aggressive in pursuing high-growth categories, for one, and with strong brand identity and an ability to pass through costs they are well positioned for the potential for still more increases in raw materials prices. Moreover, the company's food service channels are geared toward K-12 schools, colleges, hospitals and lodging chains, as opposed to restaurants.

Performance, year-over-year: + 2.9%
Performance, year-to-date: +8%

Sadia S.A. (SDA) What, you think the United States has a lock on Consumer Staples companies? SDA produces and markets frozen and refrigerated processed foods, with distribution centers in Brazil, Argentina, Chile, Uruguay, Paraguay and Bolivia. You may be thinking, "Frozen food. Great." Think again. We take frozen food for granted here in the states, but in many other parts of the world access to processed foods is relatively new and growing at a rapid rate. Processed food sales, which account for about half of SDA's revenue, grew 20% in Brazil and 31% in foreign markets SDA serves, the company said last quarter.

What's their edge? One word. Location, location, location. While China and India capture all the attention of investors hoping to take advantage of a rapidly growing middle class in those countries, Brazil is experiencing an economic boom of its own, while flying under the radar of the China-India obsessed. Brazil is among the chief suppliers of raw materials to the world. The economy is growing, but not too hot, and inflation remains in check. Just last week, Standard & Poor's upgraded Brazil to investment grade, paving the way for lower credit costs.

Performance, year-over-year: + 55.3%
Performance, year-to-date: +26.2%

Position in DAR

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