By: Steve Smith
After a few years of commanding premium valuations and leading the market higher, coveted consumer brand stocks are breaking down. Are they buys or does this bode ill for the broader market?
We all know the zero interest rate environment sent investors scurrying into stocks, especially those offering some dividend yield and acting as bond replacements. But it wasn’t just utilities, REITS and MLPS saw money flow and valuations inflate. Many large blue chip names, particularly consumer oriented names such as Nike (NKE), Starbucks (SBUX) Clorox (CLX) McDonald (MCD) and Home Depot (HD), which offered a combination of stable and steady growth along with a decent dividend, became favorites and logged high double digit gains during 2015.
But then they started losing steam in in early 2016 and by June and July they had turned decidedly downward. In fact, names such as those above and others that comprise the SPDR Select Consumer Staples (XLP) and SPDR Select Consumer Discretionary (XLY) are down 25% and more from their summertime highs.
Many are now approaching important support levels. Leading to the question – are they buys, or is a further breakdown coming, boding ill for the broader market?
Most have still to report third quarter earnings, which might be the deciding factor. But let’s turn to the chart and to identify key levels and where good risk/reward points for both bullish and bearish trades.
Starbucks (SBUX) shares have ratcheted down some 18% from the summer highs, but bounced off key support at the $52 level. After breaching $52 on Monday the company announced plans to double its store count in China to 5,000 over the next 5 years, reminding investors it still has a long runway for global expansion. The company reports earnings on November 3rd.
Clorox (CLX) shares have been bleached of 15% of their value since the summertime highs and are now at key support near the $120 level. The company has faced challenges from lower cost generics, a stronger dollar and that it’s valuation simply became too high. But at just 21x forward earnings and a 28% yield it seems reasonably valued. The $120 level offers an attractive risk/reward entry point. The company reports earnings on November 2nd.
Home Depot (HD) shares have declined some 9% from the summer highs and are sitting at key support at the $125 level. The company had benefitted from a recovery in home prices, but a continuing tight market for new sales encouraged owners to improve existing homes. That cycle seems to be coming to an end.
The chart shows little support below $125. I think it breaks lower and heads down to the $115 level. The company reports earnings November 15.
McDonald’s (MCD) shares have declined some 15% since the summer highs, but is approaching key support at the $110 level. The company has been doing a lot of good things from an operational standpoint: streamlined the menu, fixed up its stores and focused on profitable franchises. But broader trends of eating at home, eating healthier and limited expansion runway have weighed on revenue growth.
The p/e multiple has expensive 29x to a 21x and it offers a solid 3% dividend yield, making its valuation reasonable. The stock recently broke support at $114 but should gold the $110 level.
The company reports earnings Friday October 21.
The way I’d play these is simple; in MCD, SBUX and CLX, straightforward purchase of at-the-money calls with at least 3 months until expiration. Use a breach of the support levels to manage risk and exit the positions. In HD, I’d purchase puts and use a close above $130 as a stop for exiting the position.