Consumer Staples Sector

Clay DaneySubrahmanyam Darbha

Summer 2013

Agenda

• Sector Overview

• Business Analysis

• Economic Analysis

• Financial Analysis

• Valuation Analysis

• Recommendation

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

Sector Overview

• Consumer Staples Sector (S5CONS)

o Manufacturers of essential products such as food, beverages, tobacco, and household items

o People are unable or unwilling to cut consumer staples out of their budget regardless of their financial situation.

o Non-cyclical

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

Industry Classifications

Ticker Name Last Price Market Cap

Food & Staples Retailing (8 members)

WMT Wal-Mart Stores Inc $73.56 $243B

CVS CVS Caremark Corp $57.52 $72B

COST Costco Wholesale Corp $108.08 $48B

Food Beverage & Tobacco (26 members)

KO Coca-Cola Co/The $39.41 $179B

PMPhilip Morris International Inc $87.66 $147B

PEP PepsiCo Inc $79.62 $125B

Household & Personal Products (6 members)

PG Procter & Gamble Co/The $75.95 $212B

CL Colgate-Palmolive Co $56.13 $54B

KMB Kimberly-Clark Corp $94.35 $37B

Data as of: Mar 28 2013

The Key Players

Company Ticker Last Price (6-20-

13) Market Cap

Wal-Mart Stores Inc WMT $73.56 $243B

Procter & Gamble Co/The PG $75.95 $212B

Coca-Cola Co/The KO $39.41 $179B

Philip Morris International Inc PM $87.66 $147B

PepsiCo Inc PEP $79.62 $125B

CVS Caremark Corp CVS $57.52 $72B

Altria Group Inc MO $34.72 $71B

Colgate-Palmolive Co CL $56.13 $54B

Mondelez International Inc MDLZ $28.68 $43B

Costco Wholesale Corp COST $108.08 $48B

Walgreen Co WAG $48.93 $47B

Data as of: May 13 2013

Consumer Dis-cretionary;

11.78%

Consumer Staples; 11.06%

Energy; 11.48%

Financials; 15.96%

Health Care; 11.41%

Industrials; 9.73%

Information Technology;

17.30%

Materials; 3.27%

Telecom; 1.49% Utilities; 3.15% Cash; 3.19%

Dividend Receivables; 0.17%

Consumer Dis-cretionary ;

11.97%

Consumer Staples ;

9.17%

Energy ; 10.98%

Financials ; 19.34%

Health Care;

10.99%

Industrials; 10.71%

Information Technology;

15.65%

Materials; 5.16%

Telecom; 2.69%Utilities; 3.35%

S&P 500SIM

The Consumer Staples Sector•The SIM portfolio is overweight consumer staples by 189 bps

QTD / YTD Performance

Performance QTD YTD

Consumer Staples 2.67% 16.81%

S&P 500 4.45% 14.92%

Data as of: Mar 28 2013

QTD Performance

Data as of: Mar 28 2013

YTD Performance

Data as of: Mar 28 2013

Business Analysis

Stock Market Cycles “Cyclical”cycles = 4 years

“Secular” cycles = 30 years • 2011 - beginning of a cyclical bull market.

• 2013 - tail end of cyclical bull market

Business Analysis: Supply & Demand Dynamics

• Low price elasticity of demand• Low beta • Low correlation to overall market

• Producers grow by: o Reducing costs o Reducing prices o Differentiating products

• Q: Why invest in staples? • A: Slow and steady long term growth

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

The user and geography

• Consumer Staples are essential products for consumers (domestic and foreign).

• People are unable or unwilling to cut consumer staples out of their budget regardless of their financial situation.

Porter’s Five Forces

Force Characteristics Threat level

Competition -Low prices-Standardized products

High

New Entrants -Economies of Scale (high)-Barriers to entry (high)-Large Companies market share (high)

Low

Customer power -Price sensitivity (high)-Brand loyalty (low)-Best Value seekers (high)

High

Supplier power -Need for Low Input costs (high)-Raw material inexpensive

Moderate

Substitutes -Value products (low end prices)-Necessity products (fewer substitutes)

High

• Predictability and steadiness - helps match supply and demand closely

• Economies of scale - can be achieved relatively faster

• Non cyclical nature of the sector - steady growth with regular dividends throughout economic and business cycles

• Overall, the sector is well positioned for better profitability & pricing

Economic Analysis: Profitability & Pricing

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

Financial Analysis

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

Correlation - Consumer Staples & Other SPX500 sectors ’09 -’12

S5CONS S5COND S5HLTH S5FINL S5UTIL S5ENRS S5INFT S5INDU S5TELS S5MATR SPX500S5CONS 1.00S5COND 0.98 1.00S5HLTH 0.98 0.95 1.00S5FINL 0.61 0.68 0.63 1.00S5UTIL 0.96 0.93 0.93 0.50 1.00S5ENRS 0.86 0.89 0.85 0.65 0.82 1.00S5INFT 0.96 0.98 0.94 0.73 0.91 0.87 1.00S5INDU 0.91 0.95 0.89 0.80 0.85 0.93 0.94 1.00S5TELS 0.93 0.91 0.91 0.50 0.91 0.83 0.86 0.83 1.00S5MATR 0.84 0.90 0.82 0.83 0.78 0.92 0.91 0.97 0.76 1.00SPX500 0.96 0.98 0.95 0.77 0.90 0.92 0.98 0.98 0.88 0.94 1.00

Weighted Moving Average of Price

Regression - Consumer Staples & Other SPX500 sectors ‘09-’12

Source | SS df MS Number of obs = 209-------------+------------------------------ F( 10, 198) =10983.87 Model | 378539.277 10 37853.9277 Prob > F = 0.0000 Residual | 682.371554 198 3.44632098 R-squared = 0.9982-------------+------------------------------ Adj R-squared = 0.9981 Total | 379221.649 208 1823.181 Root MSE = 1.8564 ------------------------------------------------------------------------------ s5cons | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------+---------------------------------------------------------------- s5cond | -.5593398 .0628114 -8.91 0.000 -.6832049 -.4354747 s5hlth | -.758003 .0577293 -13.13 0.000 -.8718461 -.6441598 s5finl | -1.48988 .0899044 -16.57 0.000 -1.667173 -1.312586 s5util | .0567482 .0491653 1.15 0.250 -.0402066 .1537031 s5enrs | -.5348346 .032419 -16.50 0.000 -.5987654 -.4709039 s5inft | -1.176365 .0686285 -17.14 0.000 -1.311702 -1.041028 s5indu | -1.205989 .066378 -18.17 0.000 -1.336888 -1.075091 s5tels | -.7536217 .0552162 -13.65 0.000 -.862509 -.6447344 s5matr | -.2879355 .0292043 -9.86 0.000 -.3455269 -.2303441 spx | 1.883624 .1096506 17.18 0.000 1.667391 2.099857 _cons | -34.93129 4.583659 -7.62 0.000 -43.97035 -25.89224------------------------------------------------------------------------------

Weighted Moving Average of Price

Reg., Corr., Ratio - Consumer Staples on SPX500 (past 5

yrs.)

Reg., Corr., Ratio - Consumer Staples on SPX500 (past 1

yr.)

Spread Analysis (5yrs.)

Spread Analysis (1yr.)

Total Returns (monthly) - Consumer Staples (past 5 yrs.)

Total Returns (monthly) - Consumer Staples vs. SPX500 (5 yrs.)

Interpretation of Valuation Metrics• In general, Ratios/Margins are interpreted relative to other

similar companies, Industry averages.

• Stability of these ratios over time is an important indicator of risk or other appropriate parameters.

• Eg. Profitability Ratioso Gross Profit Margin – relative cost to price standingo Operating Profit Margin – measure of profitability (creditworthiness)o Cash Flow to Sales – measure of productivity and creditworthinesso Return on Assets – measure of amount of income generated per

total assets

Key highlights - valuation metrics & fundamentals

Field CY 2014 CY 2013 Current CY 2012 CY 2011 CY 2010 CY 2009 CY 2008 CY 2007

Valuation Metrics

P/E 15.95 17.55 18.28 16.02 16.17 15.57 14.88 14.18 19.51

P/B 4.04 4.25 4.47 3.82 3.71 3.42 3.31 3.36 3.99

EV/Sales 1.27 1.33 1.35 1.22 1.24 1.21 1.14 1.04 1.4

EV/EBIT 14.08 12.67 12.58 12.18 11.43 10.93 14.25

EV/EBITDA 10.04 10.75 11.55 10.37 10.38 9.99 9.34 8.96 11.58

Dividend Yield 2.98 2.95 2.87 3.23 2.9 3.18 2.9 3.01 2.34

Fundamentals

Gross Margin 29.52 29.61 30.08 30.97 30.63 29.74 30.48

Op. Margin 9.5 9.55 9.57 9.8 9.91 9.47 9.74

Profit Margin 6.23 6.22 6.06 6.5 6.21 5.6 6.35

ROA 10.36 9.81 8.34 8.24 8.39 9.58 9.35 9.44 9.16

ROE 24.79 24.26 23.37 22.84 22.02 24.23 23.35 22.64 21.24

Periodicity: Annual; Currency: USD; Units: Billion

Key highlights - Leverage & Liquidity

FieldCY

2014CY

2013 CurrentCY

2012CY

2011CY

2010CY

2009CY

2008CY

2007CY

2006

Current Ratio 1.13 1.13 1.15 1.15 1.22 1.09 1.04 1.04Net Debt to EBITDA 1.34 1.43 1.54 1.51 1.51 1.55 1.31 1.51 1.5 1.3

Total Debt To EV 0.18 0.19 0.19 0.2 0.18 0.21 0.16 0.14

Total Debt to Total Equity 87.62 84.3 82.91 78.53 68.42 82.98 71.36 63.12

Total Debt to Total Assets 31.31 30.38 29.99 29.42 27.22 30.36 27.99 24.84

Periodicity: Annual; Currency: USD; Units: Billion

Fundamentals - Income Statement

FieldCY

2014CY

2013 CurrentCY

2012CY

2011CY

2010CY

2009CY

2008CY

2007CY

2006

Income & Expenses per Share

Sales 383.76 367.23 361.73 348.87 330.89 297.51 281.46 288.18 247.82 211.38

Gross Margin % 32.72 32.66 29.52 29.61 30.08 30.97 30.63 29.74 30.48 31.19

EBIT 34.6 33.58 32.47 29.54 28.1 27.45 24.27 20.52

Margin % 9.5 9.55 9.57 9.8 9.91 9.47 9.74 9.72

EBITDA 48.5 45.31 42.15 41.04 39.38 36.01 34.35 33.49 29.88 25.56

Margin % 11.65 11.76 11.9 12.1 12.21 11.62 12.06 12.09

R&D Expense 1.75 1.71 1.56 1.55 1.61 1.76 1.49 1.41

Earnings 26.43 24.01 23.05 22.51 20.75 19.5 18.43 17.4 15.36 13.14

Earnings before XO 21.78 21.15 19.75 18.88 16.81 14.46 15.43 13.05

Diluted Earnings from Cont. Ops 23.05 22.51 20.75 19.5 18.43 17.4 15.36 13.14

Earnings, +ve 26.43 24.01 23.05 22.51 20.75 19.5 18.43 17.44 15.36 13.21

Periodicity: Annual; Currency: USD; Units: Billion

Fundamentals - Balance Sheet

FieldCY

2014CY

2013 CurrentCY

2012CY

2011CY

2010CY

2009CY

2008CY

2007CY

2006

Assets per ShareCash & Equivalents 19.94 19.37 16.34 15.23 12.94 11.41 8.63 8.03

Current Assets 83.21 82.59 82.53 71.6 63.51 62.65 57 49.62

Goodwill 63.11 61.62 59.14 56.28 50.05 47.78 46.18 31.6

Total Assets 273.43 268.2 261.81 240.51 212.73 203.6 193.93 166.66

Liabilities & Equity per ShareCurrent Liabilities 73.94 73.07 71.59 62.5 52.16 57.46 55.01 47.63

Total Debt 85.62 81.47 78.51 70.75 57.9 61.82 54.28 41.39

Total Liabilities 175.72 171.55 167.11 150.41 128.11 129.18 117.87 101.09

Retained Earnings 36.07 35.21 36.23 35.17 34.7 25.11 30.49 32.68

Book Value 104.24 99.17 94.29 94.43 90.4 88.77 82.89 73.34 75.05 64.38

Tang Book Value -7.76 -7.36 -5.68 -2.81 5.05 0.55 4.99 17.22

Total Equity 97.72 96.64 94.7 90.09 84.62 74.51 76.06 65.58

Fundamentals - Cash Flow

FieldCY

2014CY

2013 CurrentCY

2012CY

2011CY

2010CY

2009CY

2008CY

2007CY

2006

Cash Flow Items per ShareCash From Operations 34.91 31.75 32.06 31.24 26.68 25.65 26.98 23.67 20.01 18.82Cash Flow From Investing -14.41 -14.46 -8.44 -11.84 -10.6 -9.78 -12.99 -7.78Cash From Financing -14.76 -14.61 -18.23 -12.51 -14.98 -12.34 -6.61 -12.15

CapEx -10.47 -10.15 -9.75 -9.49 -9.84 -8.55 -8.63 -9.44 -8.95 -7.81

Free Cash Flow 24.44 21.62 22.41 21.82 17 17.21 18.37 14.3 11.13 11.03

Dividends 12.57 12.43 12.09 11.64 9.73 9.64 7.94 7.42 7 5.87

Dividends, Gross 12.09 11.64 9.73 9.64 7.94 7.42 7 5.87

Dividends, Net 12.09 11.64 9.73 9.64 7.94 7.42 7 5.87

Reference Items

FCF Yield 5.32 6.05 5.07 5.67 6.7 5.8 3.71 4.11

Dividend Yield 2.98 2.95 2.87 3.23 2.9 3.18 2.9 3.01 2.34 2.19

Periodicity: Annual; Currency: USD; Units: Billion

Financial Analysis:Margins

Operating Profit Margins

Gross Margins

T12M EBITDA Margins

Profit Margins

Financial Analysis:Earnings

Earnings per Share

Financial Analysis:Price Ratios

Price/FCF

Price/Earnings

Price/Book

Price/Sales

Current EV/T12M EBITDA

Financial Analysis:Equity Returns

Return on Assets

Return on Equity

Return on Capital

Financial Analysis:Income Statement

Revenues

Operating Profit Margins T12M

Valuation Analysis

Sector Overview

Business Analysis

Economic

Analysis

Financial Analysis

Valuation Analysis

Valuation AnalysisSector Valuation - Absolute

Absolute Basis Median Current

P/Trailing E 18.00 20.10

P/Forward E 17.10 17.60

P/B 4.00 4.50

P/S 1.00 1.10

P/CF 12.60 14.10

Relative Valuation

Relative to SP500

Median Current

P/Trailing E 1.10 1.30

P/Forward E 1.10 1.20

P/B 1.60 1.80

P/S 0.70 0.70

P/CF 1.30 1.30

• Sector is expensive relative to history

• Sector is expensive relative to S&P 500

Valuation Analysis

Absolute Basis

S&P 500

Consumer Staples

WMT.I

CVS.I KO.I PM.I PG.I

Super centers

Retail - Drugs

Soft Drinks

Tobacco

Household Products

P/Trailing E

15.1

19.0 16.6 16.4 20.9 19.50 19.40

P/Forward E

14.4

16.6 15.3 13.9 17.9 14.90 18.40

P/B 2.3 4.2 3.5 2.1 5.50 47.50 4.40

P/S 1.4 1.0 0.40 0.60 2.40 3.50 2.40

P/CF 10 13.4 10.9 11.40 14.60 14.80 15.0

• Relative Valuation – Industries/Companies

• Valuation varies widely amongst industries and companies within the sector

Valuation Analysis

Recommendation• The SIM portfolio should maintain its overweight to

the Consumer Staples sector. o We recommend increasing the overweight from 189 bps to

250 bps.o We recommend trimming the portfolio’s exposure to financials

and allocating those funds to consumer staples

• Rationale o The markets have run up significantly over the past 3 years. o When the current cyclical bull market turns, consumer staples

will outperform other sectors with more cyclical exposure. o Earnings are more predictable than cyclical sectorso This makes consumer staples more attractive in the event of a

market pullback.

Q & A

Appendix

Spread Analysis (5yrs.)