Consumer Staples Select Sector SPDR ETF: A Nice Defensive Choice, But Not Cheap (NYSEARCA:XLP)

ETF Overview

Consumer Staples Select Sector SPDR ETF (XLP) owns a portfolio of large-cap consumer staples stocks in the U.S. The fund basically tracks the consumer staples stocks in the S&P 500 Index. These are stocks that are much more recession resilient than many other sectors. However, stocks in XLP’s portfolio have slower growth profile than the broader S&P 500 Index and may underperform in the long-term. In addition, they are already trading at a high valuation. Therefore, investors may want to seek value in other sectors.

Fund Analysis

Stable growth, but will underperform the broader market in the long-term

Investors of consumer staples sector should not have a high expectation of juicy returns in the long-term. This is because companies in this sector generally derives their revenue from household goods, food, beverage, hygiene products, etc. While people will need these products whether in an economic boom or in an economic recession, there is only so much people can consume for these products. As can be seen from the table below, XLP’s sales and cash flow grow rates lagged the growth rates of the S&P 500 Index.

XLP

S&P 500 Index

Sales Growth (%)

4.76%

6.94%

Cash Flow Growth (%)

4.64%

7.61%

Book Value Growth (%)

0.98%

6.44%

Source: Created by author; Morningstar

These are companies with strong consumer brand awareness

XLP’s portfolio of stocks are mostly large-cap stocks that derives their competitive advantage through strong brand awareness. Companies such as Procter & Gamble (PG) is a leading household and personal-care manufacturer internationally. P&G has established several well-known brands associated with their products. XLP’s second and third largest holdings Coca-Cola (KO) and PepsiCo (PEP) also have strong brands that are well-known internationally. Many other companies such as Walmart (WMT) and Costco (COST) have many locations across North America and internationally. These two retailers should continue to enjoy economies of scale.

Ticker

Top 10 Holdings

Morningstar Moat Rating

Financial Health Rating

Weighting

PG

Procter & Gamble Co.

Wide

Strong

16.7%

PEP

PepsiCo Inc.

Wide

Strong

10.4%

KO

Coca-Cola Co.

Wide

Strong

10.1%

WMT

Walmart Inc.

Wide

Strong

10.1%

MDLZ

Mondelez International Inc.

Wide

Strong

4.8%

MO

Altria Group Inc.

Wide

Moderate

4.8%

COST

Costco Wholesale Corp.

Wide

Strong

4.4%

PM

Philip Morris International Inc.

Wide

Moderate

4.4%

CL

Colgate-Palmolive Co.

Wide

Strong

3.9%

KMB

Kimberly-Clark Corp.

Narrow

Moderate

3.0%

TOTAL

72.6%

Source: Created by author

XLP is still not cheap

Below is a table that shows XLP’s top 10 holdings. As can be seen from the table below, its weighted average forward P/E ratio of 23.05x is slightly higher than its weighted average 5-year P/E ratio of 21.16x despite the market selloff in March 2020. Therefore, XLP appears to be trading at a high valuation.

Ticker

Top 10 Holdings

Forward P/E

5-Year P/E

Weighting

PG

Procter & Gamble Co.

25.77

23.09

16.7%

PEP

PepsiCo Inc.

23.09

20.90

10.4%

KO

Coca-Cola Co.

22.52

21.92

10.1%

WMT

Walmart Inc.

25.45

18.54

10.1%

MDLZ

Mondelez International Inc.

20.41

19.90

4.8%

MO

Altria Group Inc.

9.12

16.71

4.8%

COST

Costco Wholesale Corp.

36.50

28.23

4.4%

PM

Philip Morris International Inc.

13.91

18.11

4.4%

CL

Colgate-Palmolive Co.

24.88

22.84

3.9%

KMB

Kimberly-Clark Corp.

19.23

18.60

3.0%

TOTAL

23.05

21.16

72.6%

Source: Created by author

Should you buy it now?

As discussed in our article earlier, XLP’s stocks are recession resilient stocks. In other words, their revenues should be less impacted by the COVID-19 outbreak. As can be seen from the chart below, XLP has declined much less than Vanguard Consumer Discretionary ETF since late February 2020.

Chart

Therefore, the question is whether COVID-19 can be contained by the end of Q2 2020 or whether the lockdown and social distancing in different parts of the world will continue for the rest of 2020 and extend into 2021. In the former situation, a V-shape type of economic recovery will be likely and consumer staples sector will likely underperform against other cyclical sectors (e.g. consumer discretionary, travel, and entertainment sectors) as people return to their normal lives. However, if the lockdown continues into the second half of 2020, consumer staples may continue to outperform other cyclical sectors. Investors should keep in mind that in such a situation, XLP’s fund price may still decline given its high weighted average forward P/E ratio.

Risks and Challenges

Concentration risk

XLP’s top 10 holdings accounts for about 72.6% of its total portfolio. Therefore, if any of its top-10 holdings does not live to the market’s expectations, XLP’s fund price may fall.

Exposure to international markets

Although XLP includes only consumer staples companies in the S&P 500 Index, most of these companies have sizable businesses overseas. Investors should keep in mind that many markets overseas are much more volatile and these companies’ earnings may be impacted by foreign exchange rates.

Interruption to logistics

Lockdowns due to COVID-19 may cause some interruption in logistics. Therefore, it may be difficult to ship its products to different markets domestically and internationally. Likewise, it may be difficult to obtain some raw materials from other countries.

Investor Takeaway

XLP is a good defensive choice for investors in the time of uncertainty due to its recession resilient characteristic. However, XLP is simply not cheap. Investors may want to stay on the sidelines and look elsewhere.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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