Overview

The Consumers sector is comprised of two sub-sectors, consumer staples and consumer discretionary.

The consumer staples sector includes all businesses that offer food & beverage products, household & personal products, and other necessities, which are relatively inelastic to demand conditions. Prominent names within the staples sector include: Loblaw Co. (L), Metro Inc. (MRU), PepsiCo Inc. (PEP), Proctor & Gamble Co. (PG), and The Coca-Cola Co. (KO).

The consumer discretionary sector is made up of companies operating in the retail, consumer service, and consumer durables industry. Due to the non-essential nature of these products and services, businesses in this sector tend to outperform during times of economic expansion as a result of consumer spending tailwinds. Prominent names within the discretionary sector include: Starbucks Corporation (SBUX), Home Depot Inc. (HD), Lululemon Athletica Inc. (LULU), Ford Motor Company (F), and Amazon (AMZN).

Our Senior Analyst, David Chong, Junior Analyst Alina Yao, and Research Analyst Morven Chan are providing coverage for the Consumers Sector.

Sector Themes

2015 proved to be an extremely volatile period with the crash of oil prices, shakiness in Chinese and European markets, and ended with the Fed hiking rates for the first time since 2006.

While low oil prices resulted in an increase in discretionary income for consumers, the adverse effects of the over-production of oil has put significant downward pressure on the Canadian dollar due to the economy’s reliance on commodities. The depreciation of the Canadian dollar has also been a catalyst for a shift in consumer spending habits as imported goods have become significantly more expensive. This particular trend has been evident in the food retailing industry as fresh produce sold in Canadian grocery stores are up ~18% year over year.

A large trend in the consumer discretionary sector has been the movement towards online sales platforms and the use of technology to retain consumer loyalty, which has improved the bottom line in light of spending headwinds. The consumer discretionary sector has also been affected by uncertainty in emerging markets, as volatility poses significant risks for many North American businesses looking to expand in foreign geographies. The Fed rate hike has further propelled the US dollar, and stimulating consumer spending in areas such as Europe and Asia will prove to be an ongoing challenge for these domestic businesses.

Discretionary spending has experienced changes due to dropping crude oil prices over the past several months, benefiting consumers and manufacturers alike, as spending power injection into the economy is likely, causing discretionary spending to rise. Lower energy costs may also provide tailwind for business, boosting performance due to lower input and transportation costs. The US economy’s acceleration (its fastest since 2009 has also aided discretionary spending. US home values are also expected to increase by 3.7% in 2015, compared to an average 4.3% in 2014 (Fidelity), fueling household net worth, a key driver to consumer spending which should benefit companies providing home-improvement, appliance, durable goods, and furniture retailers. Tight access to credit and a sooner-than-expected interest rate remain headwinds to new home sales growth as consumers continue to experience relative difficulty in acquiring mortgages. However given deflationary pressures from a strong US dollar, low oil prices, as well as a “strong” but not “solid” labor market, we can likely expect the Fed and other central banks to continue to be accommodative well into 2015.

Conversely, consumer staples are vulnerable to the increasing shift of investor funds towards income related securities investments in recent years, due in large part to demographics. Investors aged 65 and above carry the lowest risk tolerance, while the risk tolerance of those aged 35 and under has declined over time. Thus as a greater portion of the population retires, low risk and high yield income streams will become increasingly important. The stronger US dollar (strengthening 8% against most other major currencies) also makes it so expansion into faster growing emerging markets poses a good long run strategy, although the near term outlook for many firms operating in these markets remains uncertain. Emerging markets have become increasingly volatile due to both fluctuating currencies and structural issues like political unrest in areas like the Middle East, Russia and Ukraine and economic slowdowns in China, Brazil and Mexico. Nevertheless, currency headwinds remain a near-term risk for more internationally exposed names in the sector.

Outlook

Moving into 2016, it will be critical to monitor oil prices as discussions regarding oil production levels between major producing countries continue to unfold. Shakiness in oil futures continue to communicate the uncertainty in commodities and will remain an overhang in coming months for the Canadian dollar. Despite better than expected manufacturing data in consumer durables and automotive sales, it is highly unlikely that the Fed will continue with a March interest rate hike given the current volatility in global markets. Moving into 2016, the lack of domestic wage rate growth continues to raise concerns for monetary policymakers as unemployment figures continue to fall. Despite the strong US dollar, weak wage rate growth indicates potential domestic US consumer spending headwinds and will be an area of interest throughout 2016. The overhang of a weak Canadian dollar also presents an opportunity to find great valuations in a bear market. Notwithstanding current economic conditions, there is a large opportunity to find many fundamentally sustainable businesses in the consumer space with strong growth potential in emerging markets.