As Costs Rise, Consumer Staples and Utilities Still Better than S&P

Consumer staples and utilities have been the stocks to buy in previous market downturns. Since they make or provide products we use daily (food, water, personal care, electricity, heat), their sales are not as correlated with economic cycles as, say, those of car manufacturers.

Six months ago, I looked at how some non-cyclical stocks--Altria (MO), Anheuser Busch (BUD), Coca Cola (KO), Consolidated Edison (ED), Diageo (DEO), General Mills (GIS), Johnson & Johnson (JNJ), Kellog (K), Kraft (KFT), Pepsico (PEP), Proctor & Gamble (PG), and Reynold's American (RAI)--performed during recent market slumps and since the beginning of the decade. I concluded that owning all these stocks, especially over the almost eight year period, was much better than owning the S&P 500, even excluding dividends.

Year to date all but two of the above stocks (BUD and General Mills) are down. (If not for InBev's buyout offer, BUD would probably be in negative territory as well.)

The reasons for most of these are not hard to see. Prices for food, raw materials, and energy are soaring. This constricts margins, and profits can (and in most cases do) take a hit even if sales remain steady or rise.

Consider Pepsi and Coke, for example. Most of their beverages come in plastic bottles and aluminum cans, and are sweetened by high fructose corn syrup. The cost of plastic, a petrochemical, has gone up with rising energy prices. Aluminum prices have risen sharply since the start of the year, making cans more expensive as well. Coke recently had to bail out a couple of its bottlers as a result. The rising price of corn affects high fructose corn syrup (and many of Pepsi's snack foods). Most of the other stocks mentioned above face similar issues.

Nevertheless, the majority of the above stocks (7 out of 12) are beating the S&P year to date. Moreover, out of the 12, only Coca Cola has underperformed the S&P since the start of the decade (if we exclude dividends).

We have a similar picture when looking at a broader array of non-cyclicals. U
tilities can be purchased through ETFs XLU, IDU, and VPU. Consumer staples can be bought through KXI, XLP, and VDC. Note that KXI, the worst performer, is a global consumer staples ETF. Here's a year to date chart:

Although in negative territory, they are all outperforming the S&P 500.

The future looks brighter. Most consumer staples and utilities companies are able to raise prices to offset rising costs. As costs will eventually stabilize or go down, profit margins will expand.

If share prices dip during the upcoming earnings season, it may be a good idea to do some research and pick up a few shares of the ETFs or of companies like Pepsi.

Disclosure: Although I do not directly own any of the stocks mentioned above, I may own some or all of them through BlackRock's Enhanced Equity Yield Fund.


ESLR Update 2

Evergreen Solar (ESLR) has been dropping since its peak of $12.30 in mid June to yesterday's close, below $9 a share. If you're following this seesaw ride, I've been down 8.7% from my purchase price, then up 18.3%, and now I'm down again, this time 11.54% as of today's close. I've had a limit order in place for the other half of my planned purchase, at $8.60 a share. This morning I lowered it to an even $8, thinking it would continue falling. I guess I missed out on the pop, as the stock traded as low as $8.45 in the morning and closed at $9.20.

The reason for the latest drop, besides the weak market generally, is shareholders' negative reaction to Evergreen's offering of $325 million in senior convertible notes due in 2013. If the notes are oversold, underwriters can purchase up to an additional $48.8 million worth. The notes will pay 4% interest, and their conversion price will be $12.11 a share. Each $1,000 note is worth 82.6 shares. This can obviously have a dilutive effect.

However, ESLR also entered into a capped call with the underwriter of the transaction, Lehman Brothers, raising the conversion price to $19 a share. If in five years Evergreen trades between $12.11 and $19, Lehman will pay for the extra shares ESLR has to issue. So, if ESLR's stock price goes up, the impact on shareholders won't be as bad as it could be.

Robert Stone, an analyst at Cowen, thinks Evergreen's plan is a good one. He says it is now more likely that the company will continue its factory expansion, which will fuel earnings and revenue growth when it's completed.

Michael Carboy, at Signal Hill, considers the note offering a good idea too. He noted that the company's plan will raise cash relatively cheaply without too much of a dilutive impact to shareholders.

Evergreen has also entered into a lending agreement with a Lehman Brothers affiliate for almost 40 million shares. The affiliate will sell 18.2 million shares at $9.50, and the rest at market price.

As I think my original reasons for buying are still good, I'll continue to hold and may pick up the other half of my planned purchase if the stock falls.

The next two events that could have a major impact on ESLR's share price are its upcoming earnings report (scheduled for July 17) and congress' (in)action on alternative energy tax credits. Congress will meet for only six more weeks (three in July and three in September) this year. The current legislation expires at the end of December.