Consumer staples stocks have done reasonably well in the year-to-date period, with a combination of stable operating backdrop and the inherent defensiveness of the sector adding to the space’s allure.

On the operating front, the moderate economic recovery and improving employment scenario have been helpful. Also, lower fuel prices and rising wages have eased consumers’ disposable income. A number of major retailers and fast food chains like Wal-Mart Stores, Inc. (WMT - Analyst Report), McDonald's Corp. (MCD), and others have announced minimum-wage hikes lately, which should help the buying power at the low end of the consumer spectrum.

Commodity costs have in many cases stabilized, which have improved profit margins for certain staples companies. The favorable margins should help offset some of the negative effect that unfavorable currency typically has on earnings.

Here are some of the key factors that have been driving consumer staple stocks since the past few quarters and also have potential to boost earnings in the near term.

1. Innovations Drive Differentiation

In a crowded and competitive space, consumer product companies need to regularly innovate and upgrade their brands to differentiate their offerings.

Innovation has been a driving force for consumer product giants like The Procter & Gamble Co. (PG - Analyst Report) and cereal maker General Mills Inc. (GIS). P&G believes that consistent product innovation, supported by strong marketing and commercialization, will help deliver stronger results over the long term. The company spends around $14 billion on marketing annually.

Global brewer Molson Coors Brewing Co. (TAP - Analyst Report) also has been launching new products to boost revenues and market share, which help it to offset the impact of declining volumes. Molson Coors also invests in brand marketing and advertising to create brand awareness.

Keurig Green Mountain, Inc. (GMCR) has particularly notable with its innovative and exclusive offerings in its single-serve coffee category in order to remain competitive. The company has also entered several strategic agreements with other coffee and beverage companies like Starbucks Corp. (SBUX - Analyst Report), Unilever plc (UL - Analyst Report), Eight O'Clock Bean and Dunkin Donuts (DNKN) to offer the signature drinks of these companies in Keurig Green Mountain’s K-Cups and Vue packs.

Keurig is now partnering with The Coca-Cola Company (KO) and Dr Pepper Snapple Group, Inc. (DPS) to make Coca-Cola and Dr Pepper branded single-serve pods for use on its Keurig Cold at-home beverage system.

 
2. Shifting Focus on Health and Wellness and ‘Good-for-You’ Products

The companies are also shifting focus to make healthier and nutritious products in view of increasing health consciousness, rising obesity concerns and growing regulatory pressure.

In order to combat declining sales of the company’s carbonated beverages, three of America’s largest soft drink makers -- The Coca-Cola Company, PepsiCo, Inc. (PEP - Analyst Report) and Dr Pepper Snapple -- pledged to reduce calories in their beverages by 20% by 2025. Accordingly, the companies agreed to promote bottled water, no-or-lower-calorie beverages and smaller portion sizes to its consumers. Coca-Cola’s bottler Coca-Cola Enterprises Inc. (CCE) also committed recently to lower calories in its soft drinks by 10% per liter by 2020.

Food companies B&G Foods, Inc. (BGS) and General Mills also rolled out a variety of nutritious products in 2014 and in the first half of 2015. Natural and organic food/beverages maker The WhiteWave Foods Company (WWAV -Snapshot Report) and United Natural Foods, Inc. (UNFI - Analyst Report) have been benefiting from strong demand for natural/organic food products and expect the trend to continue.

Food and beverage companies are not the only ones trying to shift to healthier options. Tobacco companies like Lorillard Inc (LO), Altria Group Inc. (MO) and Reynolds American Inc. (RAI - Analyst Report) are also adapting to the evolving needs of consumers and have resorted to less harmful alternatives like electronic cigarettes (e-cigarettes). To cater to this, Philip Morris International, Inc. (PM -Analyst Report) plans to launch a set of Next Generation Products (NGPs) this year which will reduce the risks related to tobacco products and attract adult consumers.

3. Acquisitions and Strategic Partnerships

Consumer staple companies are regularly carrying out acquisitions both domestically and internationally to expand their existing customer base and product lines into new markets. Some of them are also forming partnerships to take a lead in this challenging environment.
Tyson Foods’ merger deal with packaged meat producer, The Hillshire Brands Company in Aug 2014 was the most talked about and the biggest deal in the meat industry.

In the tobacco industry, the long awaited merger of Reynolds American – Lorillard (announced in Jun 2014) finally received the approval from the Federal Trade Commission in May. The deal is expected to close on Jun 12.

Another big merger expected to complete in the second half of 2015 is of Kraft Foods Group, Inc. (KRFT) by privately owned ketchup maker H.J. Heinz Company. The deal has been approved by the boards of both the companies and is awaiting shareholders’ approval, regulatory approvals and customary closing conditions. Food distributor Sysco Corp.’s (SYY - Analyst Report) merger with US Foods -- the second largest player in the foodservice distribution industry == is also undergoing a regulatory review process by the Federal Trade Commission.

4. Divestitures

Companies have also been focusing on improving their product portfolio through divestitures which enable them to concentrate on their core portfolio.

The Procter & Gamble Company is in the process of eliminating 60% of the brands (roughly 100 brands) by 2016 whose sales and profits have been declining over the past three years in order to be a more focused company. Consumer giant Unilever NV (UN - Analyst Report) has also divested many businesses in 2014 to concentrate on its core products portfolio.

Similarly, in Oct 2014, Kimberly-Clark Corp. (KMB) spun-off its health care business, which is now called Halyard Health, Inc. (HYH). Snacking giant Mondelez International, Inc. (TM) proposed to spin-off its coffee business to Netherlands-based coffee company, D.E Master Blenders 1753 in order to concentrate on its core snacks business. The spin-off of its coffee business is expected to be completed in 2015.

5. Cost Cutting and Restructuring Initiatives

Most consumer staples companies are implementing cost-reduction initiatives to boost profits. Companies like McCormick & Co., Inc. (MKC), Kimberly-Clark Corp., Kellogg Co. (K), Sysco Corp., and many others have been benefiting from significant cost savings and restructuring initiatives to boost earnings.

Bottom Line

As you can see, there are plenty of reasons to be optimistic about the consumer staples industry. The sector has had a good run thus far in 2015 and one can reasonably expect this trend to continue in the near to medium term.