PSCC: The Small Consumer Staples ETF With Big Returns

Investment Thesis

There are sectors where it makes sense to diversify by size, and if the long-term returns for the Invesco S&P SmallCap Consumer ETF (NASDAQ:PSCC) are any indication, Consumer Staples is one of those sectors. Over the last decade, PSCC has outpaced the Consumer Staples Select Sector SPDR ETF (XLP) by 60%, with double-digit beats in 2013, 2016, and 2021. However, I’m concerned with its poor earnings sentiment on Wall Street and the high cost of trading, including a significant 0.22% median bid-ask spread. It’s too early to speculate, even as small-cap stocks outperform in 2023, but it’s worth placing on your watchlist if Q4 earnings season results support a sentiment shift. I look forward to taking you through the latest numbers next.

PSCC Overview

Strategy and ETF Basics

PSCC tracks the S&P SmallCap 600 Capped Consumer Staples Index, selecting securities from the S&P SmallCap 600 Index and weighting them based on free-float market capitalization. Weights are capped at 22.5%, and the sum of the companies with weights above 4.5% cannot exceed 45%, but otherwise, the strategy is straightforward. PSCC’s expense ratio is 0.29% with a 0.22% median bid-ask spread, so the cost of trading will add up. However, as I plan to demonstrate, PSCC offers a much different risk-reward profile than most Consumer Staples investors are used to, so it may be worth the price.

The Index Fact Sheet, as of December 30, 2022, lists 30 constituents with market capitalizations ranging between $358 million and $4.34 billion. Furthermore, the highest-weighted stock is at 7%, so the 22.5% cap doesn’t apply. The Index rebalances quarterly after the close of business on the third Friday of March, June, September, and December.

A legitimate concern is PSCC’s paltry $59 million in assets under management and 3K 30-day average trading volume, as listed on its profile page. That’s less than $200,000 in annual fees generated and 0.15% of the average volume for XLP. However, ETFs work differently than stocks in that market makers provide a secondary level of liquidity that keeps the market price close to the net asset value. Invesco also offers eight other small-cap sector ETFs (PSCE, PSCH, PSCT, PSCD, PSCI, PSCF, PSCU, and PSCM) with a combined $900 million in assets under management. Having a suite of similar ETFs is an advantage and makes it less likely the fund will liquidate. Nevertheless, these figures aren’t inspiring and could be why investors have ignored the fund.

Performance History

Ignoring PSCC is interesting because its performance history is outstanding. Along with Communication Services, Consumer Staples is the only sector where small caps have outperformed large caps over the last decade.

PSCC was also the best-performing Consumer Staples ETF over the same period. Below is a ten-year summary for all funds, highlighting how PSCC gained 237.84% between 2013 and 2022, 59.97% better than XLP. Furthermore, the Invesco S&P 500 Equal Weight Consumer Staples ETF (RHS) outperformed XLP by 22%, suggesting that the largest Consumer Staples securities aren’t always the best.

PSCC’s track record is characterized by a few big beats, namely in 2013, 2016, and 2021. These years, PSCC outpaced XLP by 19.04%, 22.71%, and 11.64%. Its worst year was 2019 when it lagged XLP by 10.20%. However, the underperformance is limited to 3-5% most years.

PSCC Analysis

Industry Exposures and Top Holdings

PSCC’s leading industry exposures are Food Products, Personal Products, and Food & Staples Retailing, which total 80%. It’s significantly different than XLP, where Beverage companies like PepsiCo (PEP) and Coca-Cola (KO) dominate.

The top 15 holdings are listed below, including some household names like Hostess Brands (TWNK) and WD-40 Co. (WDFC). It’s a concentrated list totaling 70.11%, but the intent behind these sector ETFs is efficiency, so it’s not a concern for me.

Macro View: Earnings Momentum By Category

PSCC underperformed XLP most years but became a better long-term performer because of a few years of significant gains. In 2023, PSCC is outpacing XLP by 3.93%, similar to the performance difference between the S&P SmallCap 600 Index and the S&P 500 Index. I attribute this to lower interest rate expectations that favor the more speculative small-caps and stronger analyst sentiment on the heels of better earnings results. Consider the median last quarter sales and earnings surprises for small-, mid-, and large-cap size and style ETFs in the following table. I also calculated a normalized Seeking Alpha EPS Revision Score for each category using holdings data for 414 ETFs.

Sentiment is not in favor of large-cap growth stocks. This category’s EPS Surprise and EPS Revision Scores are the lowest, which helps explain the poor recent performance of funds like the Invesco QQQ ETF (QQQ). However, the small and mid-cap growth categories look relatively solid, with above-average EPS Revision Scores of 5.72/10 and 5.97/10. Notably, value ETFs are lagging now, a significant shift from this time last year. These results don’t bode well for an ETF like PSCC, which is more geared toward value investors.

PSCC Fundamentals and Earnings Season Preview

The following table looks at PSCC’s fundamentals for its top 25 holdings and how they compare against XLP.

PSCC’s estimated sales and earnings growth rate is 9.30% and 13.17%, 3% and 6% better than XLP’s. Both ETFs trade at a similar 24x forward earnings, but XLP has a cheaper trailing cash flow valuation (21.73x vs. 28.02x) and is the higher-quality fund. Its free cash flow margins are 11.30% compared to 2.59% for PSCC, and its 9.35/10 Seeking Alpha Profitability Score trounces PSCC’s 5.90/10.

PSCC also has poor earnings momentum, as indicated by its poor 5.35/10 EPS Revision Score. Recall how small-cap value, blend, and growth ETFs score 5.50, 5.60, and 5.72, so this metric is slightly below average. Here’s a closer look at PSCC’s metrics as we approach earnings season.

Egg producer Cal-Maine Foods (CALM) is up 31.61% over the last year but is down 8.58% over the last month. Hostess Brands has lagged behind the small-cap market by about 6% since analysts at Morgan Stanley cut its price target. Another stock that’s pulled back recently is e.l.f Beauty (ELF). This eyes, lips, and face cosmetics company targets value-conscious Generation Z and Millennial consumers and is now trading at 44x forward earnings. Expect some of these richly-valued stocks to pull back shortly, potentially aided by weaker earnings results.

Investment Recommendation

Small-cap stocks are outperforming in 2023, likely on the basis of lower inflation and interest rate expectations. However, sentiment shifts are typically reflected in earnings revisions, and PSCC scores relatively poorly on this metric. Therefore, I recommend waiting until we receive positive earnings data next month. Remember that PSCC trades at 28x trailing cash flow, has a 2.59% free cash flow margin, and an overall poor 5.90/10 Profitability Score. It’s not exactly the safest choice should earnings season disappoint.

Still, PSCC deserves a spot on your watchlist, given its impressive track record. It outperformed the safer XLP by double-digits or more in some years, and in case you buy at the wrong time, underperformance will likely be limited to 3-5%. PSCC’s high cost of trading can add up, so a small buy-and-hold position is probably most appropriate. Nevertheless, I think the potential positives outweigh these negatives, and I look forward to providing an update on PSCC’s progress throughout the year.