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Consumer Staples Stock Recommendation

Consumer Staples Stock Recommendation. Mark Bauer and Joe Burch May 15, 2007. Agenda . Recap of sector recommendation Current SIM holdings Recommended actions Summary of stock sales Summary of stock buy Conclusion. Consumer Staples Recommendation. 9.6% of S&P 500

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Consumer Staples Stock Recommendation

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  1. Consumer Staples Stock Recommendation Mark Bauer and Joe Burch May 15, 2007

  2. Agenda • Recap of sector recommendation • Current SIM holdings • Recommended actions • Summary of stock sales • Summary of stock buy • Conclusion

  3. Consumer Staples Recommendation • 9.6% of S&P 500 • 7.8% of SIM (1.8% underweight) • Defensive (non-cyclical) stocks • Good hedge against economic downturn • Mature, slow growth companies • International growth is important • Brand is important to generate high margins • Valuations do not suggest that consumer staples is cheap • Maintain underweight position

  4. Current Holdings

  5. Recommendation • Sell 142 BP of Altria • Sell 130 BP of Kraft (all) • Buy 272 BP of Colgate • No change to Anheuser-Busch

  6. Kraft - Food products industry • Industry dominated by large companies such as Kellogg, General Mills, Campbell, Heinz, and Sara Lee • Utilize economies of scale • Competition based on price, quality, and variety • Strong brand enables higher prices • Trends/Issues • Healthy eating and organic foods • Regulation and labeling • Competition from lower priced private label competitors

  7. Kraft – Business Analysis Negatives • Operating margins decreased 14% in Q1 2007 from 15.2% to 14.0% • Investments in marketing, quality improvements, systems and distribution architecture, soaring ingredient costs, competition from generic brands • Lost market share on trademark products such as cheese, coffee, and salad dressing • Organic revenue up 3.6% and 2007 guidance is 3-4% Positives • Earnings beat consensus estimates by $.02 per share • Looking for possible acquisitions to build scale in international markets, enter new categories, or acquire new technologies • Independence from Altria will provide more flexibility for acquisitions

  8. Kraft – Valuation Analysis • P/Forward E in-line with 5-year mean • Slightly expensive relative to S&P 500 and sector • Limited upside based on valuation analysis. Priced target of $34 (4% upside) • Summary: Not attractive based on valuation

  9. Kraft – DCF Analysis

  10. Kraft Summary • Weak results and outlook • Moderate upside potential based on valuation analysis and price target • Poor DCF target price • Sell entire holding and move money to higher growth stock

  11. Altria Positives • Phillip Morris International (PMI) growth is strong (9.5% income growth) • Looking to spin-off PMI • Analyst believe spin-off could result in share buybacks and share price increases • Key strategic event from Q1: Spin-off of Kraft • Focus on growing tobacco business • Raised full-year guidance • Expecting margin improvement • DCF target price is $78 (13% upside) Negatives • Q1 earnings lower than expectations • Phillip Morris USA had a weak quarter • Domestic cigarette sales volumes declined 6.2%. Decline expected to moderate to 3-4% throughout the year. • Risks: Smoking bans, health concerns, litigation Conclusion • Sell 142 basis points to diversify the staples portfolio and move the money to higher potential stock

  12. Colgate-Household Products Industry • Very mature industry with many familiar companies vying for market share. • Brand name is a big factor like other industries in the sector. • Competition and leverage from large retailers restrict price increases. • Companies rely on product innovation to bolster sales and profit margins. • Cost control is done effectively and more efficient operations are being employed.

  13. Colgate-Business Analysis Positives • Gross margin of 56.4% in Q1 2007 compared to 54.5 % in Q1 2006. • Undergoing restructuring plan which includes increased product innovation, more efficient spending on marketing, closing of 1/3 of CL’s factories and more focus on faster growing markets. • Smooth CEO transition is expected. • Reuben Mark, CEO since 1984, is retiring on 07/01/07. COO and long-time Colgate employee will become CEO. Negatives • Modest growth numbers domestically. • Cat food recall • Not expected to have a significant impact on Colgate’s financials.

  14. Colgate • Growth • Notice the higher growth internationally.

  15. Colgate • Market Share • Achieved an all-time high of 37.3% of the toothpaste market in the U.S. • Market leader in 53 of the 71 largest toothpaste markets worldwide. • Growth within developing markets is projected to rise 2-3 times that of developed markets in near term.

  16. Colgate - Valuation • Price steadily increasing along the trend line. • P/E cheap on an absolute level and inline relative to its sector. • Historical P/E a little higher than sector average.

  17. Colgate Summary • Generating higher margins through restructuring plan. • Excellent international growth. • Leading share in most major markets. • Target price: 80.27, 21.0% upside.

  18. Recap • Sell 142 BP of Altria • Sell 130 BP of Kraft (all) • Buy 272 BP of Colgate • No change to Anheuser-Busch

  19. Questions?

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