While profits elsewhere soar, consumer companies have hit a wall

Investing & Retiring

“In 1Q, the market’s response to earnings releases of Consumer Staples companies has been the worst of any sector,” Jonathan Golub, chief U.S. equity strategist at Credit Suisse, said in a note to clients. “This weakness is largely the result of margin pressures across all Staples sub-sectors, stemming from lack of pricing power and rising input and commodity costs.”

In fact, that big headline number isn’t what it appears.

Of the 13 percent growth, 11 percentage points have come from benefits due to the big slash in corporate taxes from 35 percent to 21 percent.

The story has been somewhat different for discretionary. That sector is projected to see earnings growth of 23 percent, with 13 percentage points fueled by the tax cuts and another 3.3 percentage points the result of share buybacks. The Consumer Discretionary Select Sector SPDR ETF has been a strong performer, gaining about 6 percent on the year and outperforming the market.

But there’s even bad news there — excluding the tax and buyback benefits, earnings are up only about 6 percent, which Golub said is the weakest of all cyclical sectors. Share repurchases for all companies are averaging $7.8 billion a day in what is expected to be a record year, according to market research firm TrimTabs.

“This stems from structural headwinds for many brick and mortar retailers, tepid subscriber trends at cable providers, and normalization in new car sales; partially offset by positive secular tailwinds in internet retailing and online media distribution,” he wrote.

Some hope lies ahead, though.

Consumer sentiment remains strong and savings rates are continuing to decline, indicating an appetite for spending. Capital expenditures also are on the rise, with an annualized rise of nearly 25 percent reported in the first quarter.

Profits are expected to improve as well, with staples projected to see earnings per share gains of 9.5 percent and consumer discretionary 15.5 percent in the second quarter, according to FactSet.

Also, individual tax cuts have only started to funnel through the broader economy, indicating that at least for the moment, the outlook on the battered consumer sector could begin to improve. Real consumption took a dive in the first quarter to 1.1 percent, indicating considerable room for improvement, according to BNP Paribas.

“The tax cuts this year mean most forecasters, including us, have robust consumption growth
this year,” Paul Mortimer-Lee, chief market economist at BNP Paribas, said in a report for clients. He added that “things seem to have hit the wall in 2018. … The key issue is whether this is
an aberration or are consumers adjusting the pace of consumption down more enduringly?”

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