Consumer Theme

You might think about consumer staples as a contrarian play in a forgotten sector. Consumer staples in Canada, which includes the largest grocery and drug retail chains, has been quietly climbing a wall of abandonment since late last year. And with volatility levels in the lowest quartile of all Canadian options, premiums are relatively inexpensive.

When you combine the lack of attention afforded stocks in this sector, cheap options, and the rise within the sector since the beginning of the year, call buying strategies have been, and still look, interesting.

To buy into the sector, you have to buy into strong consumer demand. If consumer spending slows, as a number of analysts are predicting, the sector is particularly vulnerable. The voracity of spending depends on how confident consumers are at a point in time. And that rests in large part, on a stable housing market and rising employment data. For Canadian consumers, those components seem to be in place.

Not so much in the US, where housing prices are experiencing a double dip, pushed lower by tight credit and the resurgence in foreclosures. And while US employment data is improving, it remains sluggish.

There is also a longer term debate around demographics. Some have argued that baby boomers are aging, and as such, don’t have the same propensity to spend. It is not that boomers are slowing down, but what does one buy in a demographic that has everything?

Still, recent numbers from US retailer Macy’s showed surprising resilience. Macy’s along with a number of middle to high end US retailers, reported quarterly earnings well above expectations. And while a quarter does not a trend make, one could say that the death of the consumer is greatly exaggerated!

From this preamble, there are two things to think about; 1) to what extent do market watchers tie US consumption habits to Canadian consumers and 2), is the longer term demographic story relevant to the Canadian consumer?

Given there are such pronounced differences of opinion around this subject matter, you might want to look at companies in the consumer staples space whose profits are not so cyclical as to be dramatically impacted by consumer sentiment.

An example would be George Weston Ltd (TSX: WN, Recent price $71.03), one of Canada’s premier food processing and distribution companies. Through its major interests in Loblaw Cos. Ltd. and Weston Foods, the company plays a leading role in Canada’s grocery landscape.

Certainly the company’s earnings are moving in the right direction. In the first quarter George Weston reported earnings of $0.74 per share, up from $0.21 per share in the same period last year.

Technically, one could make the case that WN has bottomed after a sharp sell-off in the first quarter. Could that be the result of a rotation out of energy issues and into stocks like WN? If WN were to advance back towards to the middle of its six month trading range, traders would be looking at $76 per share or better. With WN options trading at 18% implied volatility, call buying would be a way to play that point of view.

Bullish traders might consider buying the WN June 72 calls at 85 cents or the WN June 74 calls at 30 cents. Always remember with any speculative trade, should the calls double in price, take half profits.