We lay out 3 key debates we expect to drive stocks in 2016. In terms of valuation, we see support from solid operational performance with top lines inflecting, solid margin uplift and focus on capital deployment. A 'Self-Help' theme informs our top picks: Danone, Nestle, Reckitt, Beiersdorf.
Addressing three key debates for 2016 – EU Food / HPC valuation
supported by a solid operational outlook. Whilst investors are focused on
the top-down risk to Consumer Staples from sector rotation out of defensive
sectors in anticipation of rising interest rates, we adopt a bottom-up
perspective and see a relatively solid outlook in the coming 12 months.
Three debates that we think will drive relative stock performance in 2016 are:
1. Can organic growth in Food/HPC improve in 2016? We believe the
market is underestimating the potential for improved top-line growth with
Emerging Markets stabilizing, ongoing investment in growth, partlymoderating
competitive pressure and easing comps.
2. Can ‘Self Help’ become a key earnings driver in 2016? We expect
intensified focus on efficiency gains, portfolio changes and M&A to drive
earnings, whereas consensus estimates seem to reflect caution. In particular,
we think margins could surprise on the upside.
3. Can current high multiples be sustained? A key concern in the market is
that with the average EU Food/HPC rel. P/E sitting on a lofty ~50% premium
vs. MSCI Europe (albeit in line with long-term multiples) having outperformed
~20% in 2015 (driven by HPC), the likely imminent increase in interest rates by
the US Fed raises the prospect of a sector rotation out of defensive stocks
affecting staples' valuations. We acknowledge this as a risk for 2016, but see
solid operational performance as supportive (e.g. in contrast to other sectors,
we saw no profit warnings in the recent 3Q results; indeed, most reported
better-than-expected results with some (e.g. Reckitt) even raising guidance).
For 2016, Danone and Nestle are our preferred stocks in Food; Reckitt
and Beiersdorf in HPC. Our top picks are those with the most scope for 'Self
Help' to drive margins and to reinvest to support top-line growth. We also
believe the EU Food and HPC stocks will benefit from improving DM,
stabilizing EM and mix improvement, and again see Danone & Nestle in Food
and Reckitt & Beiersdorf in HPC as preferred stocks to play this improving
EM/top-line inflection theme.