Last week, at least one consumer discretionary stock per day reported a positive earnings surprise. The question I'm asking myself is whether this is a function of an improving economy or a group of analysts stymied by the ups and downs of a sector supposedly in the doldrums. Some of these upside surprises haven't just been by one or two percentage points; rather they've been beating estimates by 20% or 30% or more. Something is happening here; I just can't figure out what it is.
Perhaps by looking at some of the companies that have beaten estimates and how they did so, I'll better understand what's to come, good or bad. Either way, consumer discretionary stocks are doing much better than expected, and that's definitely a good thing. (Consensus estimates can send stocks spiraling, but are they representing reality? Check out Surprising Earnings Results and Strategies For Quarterly Earnings Season.)
Two Opinions For Every Subject
In life, it seems that no matter what the discussion is about, inevitably a negative opinion counters every positive viewpoint and vice versa. Consumer discretionary stocks are no different. In a recent article in Barron's, Jason DeSena Trennert, the chief investment strategist and managing partner for New York-based Strategas Research Partners, predicted we will experience a period of "reflation" in 2009 when inflation comes to life for commodities such as energy, basic materials and gold.
The days of consumers spending like drunken sailors are over. In 2008, consumer spending reached an all-time high of 71% of GDP, much higher than the 65% long-term average. A drop to historic norms would shrink spending by $850 million, which clearly will affect consumer discretionary stocks. Trennert is a big bear.
For the opposite viewpoint, look no further than Charles Schwab's director of sector analysis, Brad Sorenson, for a much more bullish opinion. In mid-April, Sorenson upgraded the sector to "Outperform", suggesting that stock prices already reflect the bad news in the economy, including a permanent reduction in spending and simultaneous increase in savings. While the two analysts agree on future consumer spending habits, they differ greatly on the effect it will have on consumer discretionary stocks. I tend to favor the bullish view because I find it hard to believe Americans will be able to resist opening their wallets once the economy improves. (What people buy and where they shop can provide valuable information about the economy. To learn more, read Using Consumer Spending As A Market Indicator.)
Latest Earnings Surprises
|Company||Positive EPS Surprise|
|Wolverine World Wide (NYSE:WWW)||32.26%|
|Deckers Outdoor (Nasdaq:DECK)||45.31%|
Beating The Street
All five of the above companies beat analyst expectations in their latest quarter. Pepsi's Q1 results beat by 4 cents, or 71 cents versus an average estimate of 67 cents. Even more important is that Pepsi's management affirmed its full-year guidance and announced a $6 billion offer for the shares it doesn't already own in Pepsi Bottling Group (NYSE:PBG) and PepsiAmericas (NYSE:PAS), its two biggest bottlers. I personally have never understood why Coke and Pepsi operate such convoluted ownership structures. This should make future decisions far more efficient for the parent company. It's a great move, in my opinion, regardless of whether they have to add another 10% premium to the deal.
Next up is brand conglomeration Jarden. In the last year, I've written two articles about the company, one good and one bad. Its latest report shows it's continuing to hammer away at its expenses, doubling earnings per share (EPS) to 12 cents from 6 cents a year earlier. Even better, it announced April 22 that it was selling 12 million shares at $17.50. While it's not a huge dent in its $2.77 billion long-term debt, it's a step in the right direction. I like this stock more every day.
Now We Get Into The Bigger Surprises
Nothing Deckers does is a surprise given the success of its UGG boots. It's been beating estimates for a long time. Much more surprising is the 32% beat by Wolverine World Wide. Analysts expected Wolverine, the maker of Hush Puppies, to earn 30 cents a share in the Q1 before special charges. It came in 11 cents higher at 41 cents with sales down just 5.2% adjusting for restructuring costs. It's a great start to the year - one the footwear industry expects will be very difficult. Lastly, Xerox's Q1 wasn't great, but it was better than analyst expectations by 5 cents to 4, and 32 cents better year-over-year. Despite cutting 2009 EPS in half, it still appears to be a reasonable deal.
Despite a lot of question marks with consumer discretionary stocks, I believe they present some of the best opportunities right now precisely because of these uncertainties.