Consumer staples sector

Consumer staples stocks had a challenging year in 2023. But with valuations now compelling and profit margins and volumes potentially poised to rise in 2024, I believe the sector could have a better year ahead of it—particularly if defensive and dividend-paying stocks come back into favor with investors.

2023: Squeezed from both sides

The consumer staples sector encompasses makers of everyday items like packaged food, toothpaste, and dish detergent. It's considered to be a "defensive" sector because consumers tend to still buy such products even when times are tight, and because it includes many mature dividend-paying companies.

But that positioning was a drag, not a boost, on performance in 2023, when investors shunned defensive stocks and showered favor on a narrow segment of mega-cap growth companies (particularly those with ties to artificial intelligence).

At the same time, fundamentals at many companies were squeezed by a challenged consumer. Inflation has pressured these companies for the past 2 years, with some brand-name companies losing market share to generic (also known as private-label) alternatives. In a bid to grow sales volume and market share—and responding to input costs that eased in the past year—some companies slowed their price increases in 2023 and offered more discounts. But this led to decelerating revenue growth in the sector in 2023, which weighed on the stocks even as companies delivered better-than-feared earnings. Higher interest rates also lured many investors toward fixed income and away from dividend-paying stocks.

Among the hardest hit segments was packaged foods and meats, a competitive industry due to the presence of lower-priced private-label alternatives. As input costs eased, name brand food companies stepped up discounts and advertising spending to attempt to gain market share. However, few saw the hoped-for increase in sales volumes. Investor sentiment also shifted against this segment due to worries about how new weight-loss drugs might impact demand.

That said, some segments had a better year than others. Household products companies, for example, saw notably higher gross profit margins, driven by significantly lower input and freight costs

Brightening outlook for 2024, but with risks

Key for the sector in 2024 may be whether sales volumes improve, with consumers coming back to more brand-name items. If volumes rise, consumer staples companies will likely feel less pressure to ease prices, which would in turn help profit margins. Firms that boosted promotional and advertising spending in 2023 may have an added tailwind. Meanwhile, valuations in the sector have looked compelling versus the broader market and versus sector history. Any decline in interest rates could also boost the attractiveness of dividend-paying stocks.

One unknown—for both 2024 and the longer term—may be the impact of the new weight-loss drugs. How many people will take these drugs and what their effect on sales will be is not yet known. Packaged foods and soda companies may be the most at risk, whereas household products companies and retailers may be less exposed.

A focus on pricing power

I believe that companies with attractive valuations and strong pricing power may offer the strongest returns potential for 2024. Companies that can raise prices or hold them steady may be more likely to meet their profit-margin forecasts. And companies that have invested gains in advertising and long-term brand building may have an added tailwind.

Among the best positioned for 2024 may be household products companies, due to sticky pricing, positive trends on sales volumes, and earnings flexibility.

Brand-name soda makers may have the ability to retain or raise prices, because they face little competition from lower-cost, generic alternatives.

A healthy demand base, and potential for improvement

Although the economic outlook remains uncertain, consumers are likely to continue to need the everyday products—from toothpaste to toilet paper—that staples companies produce and sell. When exactly sales volumes pick up may depend on the health of the consumer and economy. However, valuations in the sector remain compelling, especially given the potential for improving profit margins.