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ConAgra Foods, Inc. (CAG), Kellogg Company (K): Two Staples to Sell, One to Keep

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Consumer staples companies manufacture and sell products such as food, beverages, tobacco and household items. They are products that consumers are unable of unwilling to cut from their budgets. These stocks are considered non-cyclical because the overall economy will not impact consumer demand.

Since the beginning of the year, the consumer staples sector has been outperforming the S&P 500.

As the markets continue to grow, so does the talk about a pullback or a slow summer.  Beyond a pullback, there has also been talk of sector rotation, as investors move to sectors that have been underperforming.  Given the recent outperformance by consumer staples, we look at three consumer staples stocks that could by very vulnerable to a correction.

Brands You Know and Love

ConAgra Foods, Inc. (NYSE:CAG) includes brands include Banquet, Blue Bonnet, Chef Boyardee, Egg Beaters, Healthy Choice, Hebrew National, Orville Redenbachers, and Del Monte.  The company continue to trade near its 52-week high and is up roughly 18.5% year-to-date, in line with the consumer staples segment.  However, the most recent quarterly announcement raised some issues.  Sales volume was down 3% from the same quarter in the prior year despite a 33% increase in marketing spending. The company said that it expects sales volume in the next quarter to be much stronger. The report led to several analyst downgrades.

Kellogg Company (NYSE:K) manufactures and markets ready-to-eat cereal and convenience-food products primarily in North America, Europe, Latin America, and  Asia-Pacific.  The company’s brands include Kellogg Cereals, Keebler, Cheez-It, and Famous Amos. The company’s recent quarterly report raised some issues.  While internal net sales – which exclude the effects of foreign currency translation, acquisitions, dispositions, and integration costs – rose by 2.2%, internal operating profit decreased by 5.8%.  This decrease was driven largely by inflation in cost of goods sold.

Lastly, we have everyone’s favorite confectioner, The Hershey Company (NYSE:HSY). The Hershey Company (NYSE:HSY) brands include Reese’s, Twizzler, Jolly Rancher, Cadbury and KitKat.  The most recent quarterly report showed strength as net sales increased 5.5%, driven by volume.  The company also expected full-year net sales to increase by 5%-7%, also driven primarily by volume.

Lofty Valuations

ConAgra Foods, Inc. (NYSE:CAG) currently trades at a P/E ratio 29.75 versus an industry average of 23.14 and a five-year average of 16.11. Kellogg Company (NYSE:K) trades at a P/E of 25.54 versus a five-year average P/E of 16.30. Hershey trades at a P/E of 28.72 versus a five-year average of 23.02.

To keep things in perspective, it is worth noting that Google currently trades at a P/E of 27.  So we have three consumer staples companies trading near or above the valuation of a technology giant still thoroughly in growth mode.

Are These Companies for Real?

Based on these valuations, the question becomes do these companies have strong growth prospects or have they been driven by the performance in the sector.  If the latter is the case, the stocks could be vulnerable to a pullback or a shift in investor sector allocation.

ConAgra Foods, Inc. (NYSE:CAG)’s recent struggles raise many questions about financial strength in the future.  The decrease in sales despite the large increase in spending raises concerns about expenses and product management.  Coupled with analyst downgrades, I would avoid this stock.  Likewise, Kellogg Company (NYSE:K)’s cost of goods issues are likely to persist and could continue to impact margins.  The grains required for cereals are highly volatile in price and may make it difficult for Kellogg Company (NYSE:K) to properly budget and predict future earnings. Despite its relatively low P/E versus ConAgra Foods, Inc. (NYSE:CAG) and Hershey, I would avoid this name as well.

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