Insights -- June 2005
Our A.G. Edwards market strategist
continues to recommend overweighting Consumer Staples in light of the continuing controversy introduced by high oil prices, rising interest rates, a generally weak dollar, among others. In this environment, we continue to assess the defensive characteristics of this sector, which is battling pervasive commodity cost inflation (resin and fuel at present) and slack demand around higher oil prices. In an effort to combat this commodity cost inflation, most companies are undertaking a more aggressive push to realize pricing at retail attempting to more appropriately balance the volume/price equation. We could price realization as the strategic pillar for earnings growth across the group and we continue to forecast strength in pricing in 2005 (we estimate two percent-type price realization for the large-cap food companies). To the extent this pricing coincides with what looks to be very moderate growth ahead in commodity cost inflation, the margin structure of the group should improve. We continue to forecast a nearly 30 basis point improvement in gross margins across the large-cap food group during this period of price inflation. Private label serves as the "governor" and in certain categories, particularly commodity-oriented food categories, we may well see heightened competitive concerns surface. The ready-to-eat cereal category is a case-in-point where aggressive price competition from private label is stymieing the price realization expected by this time among the branded competitors.
Food For Thought
The food group is outperforming the market by nearly two percentage points in a year in which the earnings growth trends are less than stellar on a group-wide basis. We estimate approximately 5 percent EPS growth for the food industry. We continue with our neutral weighting of the food manufacturers noting the relatively full multiple in place today for the overall group compared to the market and historical context (5 percent premium). In viewing the Consumer Staples sector as a whole, we do acknowledge that food stocks, tobacco stocks and brewing stocks, stand as the only three subgroups that reside below the Consumer Staples average P/E multiple today indicating that "value" oriented investors may seek out these subsectors when attempting to force a more defensive bias in their portfolios. With such disparate fundamentals in place for the food group, we do not foresee considerable multiple appreciation ahead. Instead, we predict a
continued widening of the multiples within the group - the "cream of the crop" will continue to outperform in our opinion and the multiple gap within the group will widen further. While the phrase "a rising tide lifts all boats" does not necessarily apply here, we do believe most subgroups within Consumer Staples would likely see some benefit from investors searching out stability in mature businesses present in this industry. And, with fundamentals disparate across even the Consumer Staples sector, much less the food stocks, multiple appreciation across the sector may not be as widespread.
The Home Depot To Standardize Systems
Home improvement retailer aims to increase operational flexibility on a common platform At SAP's international customer conference last month, The Home Depot announced a new partnership with the ubiquitous business software solutions provider that reinforces the company's commitment to technology innovation. The partnership is the next step in the company's multi-year strategy to implement standardized systems and platforms and build a robust IT infrastructure.
The partnership will also provide significant opportunity for The Home Depot to utilize SAP solutions to enhance its retail operations and support its other growth businesses. Implementation of the new software solutions and platforms will ultimately provide specialized merchandise assortments and promotions at the individual store level, increase operational flexibility by providing a common platform to grow the business and significantly improve visibility and efficiency throughout the supply chain.
"By leveraging the expertise and global leadership of SAP, we will accelerate our ability to bring new solutions to our associates and provide better choices and services for our customers," said Bob DeRodes, executive vice president and CIO at The Home Depot. "We want the very best technology available to enhance our overall performance and provide a flexible platform to support expansion in a variety of new formats."
To execute this strategy, The Home Depot will work with SAP to deploy an enterprise suite of software products, based upon SAP for Retail solutions, to enhance the company's merchandising and supply chain activities. The Home Depot will become an SAP Global Alliance Account and will serve as SAP's retail sector "lighthouse" account, enabling the two companies to partner in the research and design phase of new capabilities to stay ahead of marketplace demands and create unique, highly flexible applications.
The partnership continues a long line of technology investments recently made by The Home Depot. The company is the first in the home improvement industry to deploy self-checkout, with more than 1,000 stores equipped with "do it yourself" checkout stands. Other initiatives include a range of technology rollouts to enhance the customer experience and improve associate productivity. During the last two years, The Home Depot has installed hundreds of thousands of new devices in its stores, including cordless scan guns and point-of-sale (POS) terminals, and has completely revamped its store network and wireless capabilities.
About The Home Depot
Founded in 1978, The Home Depot is the world's largest home improvement specialty retailer and the second largest retailer in the United States, with fiscal 2004 sales of $73.1 billion. The company employs approximately 325,000 associates and has 1,912 stores in 50 states, the District of Columbia, Puerto Rico, 10 Canadian provinces and Mexico. The company recently announced the creation of a business development operation for retail expansion into China.