2023-04-19 22:43:42 ET
Summary
- PSCC is a small/mid-cap play in the defensive stock universe, in the current iteration focused on the food (close to 39%) and personal care products (26.9%) industries.
- In the past, the ETF demonstrated fairly robust performance, with results delivered during the 2022 bear market being especially remarkable, with the downside being its relatively high standard deviation.
- Compared to XLP, the fund does offer a better valued mix; however, lower multiples come with quality issues under the hood.
- Investors should pay attention to quality and liquidity risks. In sum, PSCC is only a Hold.
With the recession risk being worthy of concern, investors might consider tilting their portfolios towards defensive sectors like consumer staples, utilities, or healthcare. But the essential issue here, which I have already discussed in my article on the First Trust Consumer Staples AlphaDEX ETF ( FXG ) published in January, is that large-size players from industries that proved their relatively immunity to economic downturns are almost always priced at a substantial premium to the market, and for investors seeking to balance defensive exposure with value, ETFs that target top players like, for instance, the Consumer Staples Select Sector SPDR ETF ( XLP ), would be a suboptimal choice. One of the possible solutions (and potentially the simplest) is to apply a size filter. Put another way, to replace large-caps with smaller-size stocks to make valuations more comfortable across the portfolio.
Invesco S&P SmallCap Consumer Staples ETF ( PSCC ) is an index-tracking fund designed to provide exposure to the consumer staples players from the U.S. small-cap echelon. In theory, this fund should represent an ideal solution to the mega-cap consumer staples perennial overvaluation problem. However, as I will illustrate below, though a few of this ETF's weighted-average multiples are lower than XLP's, its comparative inexpensiveness is primarily driven by the quality discount.
In this regard, I would recommend proceeding with caution with PSCC, not only due to quality disadvantages uncovered, but also because of the liquidity issues of this fund which has an AUM of just $69 million. Overall, I believe it is only a Hold.
Pros: valuation and performance
Valuation is relatively cheaper compared to XLP
According to its website , PSCC tracks the quarterly rebalanced and reconstituted S&P SmallCap 600 Capped Consumer Staples Index, which is essentially a fraction of the well-known U.S. small-cap barometer, the S&P 600. As of April 17, PSCC had 30 holdings, with the most expensive company in the mix being e.l.f. Beauty ( ELF ), with a market cap of $4.8 billion and a 9.3% weight in its portfolio.
There are a few indications of PSCC's more comfortable valuation compared to XLP investors should pay attention to.
- First, there is a substantial difference between weighted-average market capitalizations, with XLP's concentrated portfolio of 37 stocks having $173.6 billion, as per the fund's website , and PSCC's 30 equities-strong basket having $2.65 billion, as per my calculations.
- As valuation becomes less comfortable when market cap climbs higher and vice versa, PSCC's WA earnings yield of 4.9% compared to just about 3.95% of the Consumer Staples Select Sector Index is no surprise.
- However, investors may justly question the reliability of the traditional earnings yield for portfolios with large exposure to the debt-heavy companies, and PSCC, unfortunately, is one of the examples, as we see a meaningful spread between its WA market cap and enterprise value, $2.65 billion vs. $3.2 billion, as per my analysis.
- So to add borrowings to the equation, we can opt for Enterprise Value/EBITDA or its inverted version, the debt-adjusted earnings yield. Here, a strange deviation can be uncovered, as XLP is trading with a ratio slightly above 18x and PSCC is trading with 18.99x.
- This is a deviation worth elaborating on. The essential culprit is the impact of ELF, which had a 60.7x EV/EBITDA as of April 18; XLP had no exposure to stocks priced that generously on an EV/EBITDA basis, with the highest multiple in the mix being Monster Beverage's ( MNST ) 34.3x.
- For better context, Enterprise Value/Sales, which is immune to the margin compression issue which can distort the debt-adjusted EY, should also be considered. In contrast to EV/EBITDA, EV/S illustrates that XLP is much more expensive with its 3.69x vs. PSCC's 2.7x.
- With that being said, I believe the best instrument for the creation of a comprehensive view of both funds' value exposure is to use the Seeking Alpha Quant Valuation grade. Here, PSCC obviously has an edge, with 27.7% of holdings having a B- grade and better (as of April 18) vs. XLP's 15.8%. Besides, relatively overvalued names (D+ and worse) accounted for 75.3% of the SPDR fund and just about 35.7% of the Invesco fund.
PSCC outperformed IVV and XLP during the May 2010 - March 2023 period
Another advantage is that PSCC can be justly proud of its past performance. Incepted in April 2010, during the May 2010 - March 2023 period, the ETF delivered a compound annual growth rate of almost 13%, outperforming the market, in the dataset below represented by the iShares Core S&P 500 ETF ( IVV ), by 74 bps. Other funds selected for comparison including the iShares Core S&P Small-Cap ETF ( IJR ), XLP, and FXG also had weaker total returns over that period, though it should be noted that XLP had a much lower standard deviation and higher risk-adjusted returns (the Sharpe, Sortino ratios).
Portfolio | PSCC | IVV | XLP | FXG | IJR |
Initial Balance | $10,000 | $10,000 | $10,000 | $10,000 | $10,000 |
Final Balance | $48,315 | $44,376 | $38,365 | $39,496 | $36,780 |
CAGR | 12.97% | 12.23% | 10.97% | 11.22% | 10.61% |
Stdev | 15.68% | 14.87% | 12.13% | 13.54% | 19.22% |
Best Year | 45.34% | 32.30% | 27.43% | 42.25% | 41.32% |
Worst Year | -6.71% | -18.16% | -8.07% | -11.49% | -16.19% |
Max. Drawdown | -24.10% | -23.93% | -13.63% | -19.73% | -36.12% |
Sharpe Ratio | 0.81 | 0.81 | 0.86 | 0.8 | 0.59 |
Sortino Ratio | 1.34 | 1.26 | 1.46 | 1.36 | 0.89 |
Market Correlation | 0.69 | 1 | 0.7 | 0.75 | 0.91 |
Created by the author using data from Portfolio Visualizer
To give a bit more color, I also compared its monthly and annual returns to IVV's. Here, perhaps the most interesting fact is that PSCC beat IVV by 11.5% during the 2022 bear market, most likely thanks to its value factor exposure.
Cons: a quality discount
In most cases, there is a justification for cheaper valuation. It could be softer growth or lackluster quality, or both. Unfortunately, in the case of PSCC, the higher earnings yield and lower EV/S are likely supported by the quality discount. Let me elaborate on that.
- First and foremost, a significant share of its holdings (12.4%) have negative net operating cash flows; considering the nuances of operations in the consumer staples sector, this is more likely due to working capital issues. Nevertheless, only one XLP holding has a cash flow issue, Bunge ( BG ), which accounts for just 60 bps.
- XLP's weighted-average EBITDA margin of 20.6% (with the major contributors being tobacco heavyweights Altria ( MO ) and Philip Morris International ( PM )) vs. PSCC's 14.2% is rather telling.
- XLP's WA Return on Total Capital is also higher, 13.2% vs. 11.4%, again thanks to the contribution from MO and PM.
- Ultimately, and most importantly, only about 46.3% of PSCC's holdings sport a Quant Profitability grade of B- and higher vs. over 99% in XLP, which as of April 18 had exposure to only one stock with profitability issues , namely Bunge.
Investor takeaway
PSCC is a small/mid-cap play in the defensive stock universe, in the current iteration focused on the food (close to 39%) and personal care products (26.9%) industries. It has a modest expense ratio of 29 bps.
In the past, the ETF demonstrated fairly robust performance, with results delivered during the 2022 bear market being especially remarkable, with the key downside being its relatively high standard deviation. Compared to XLP, the fund does offer a better valued mix; however, lower multiples come with quality issues under the hood. Assuming XLP's holdings are much more profitable, it should be a better choice for investors seeking to position for a potential recession. FXG which I discussed in January is also a better option to consider. In sum, PSCC is only a Hold.
For further details see:
PSCC: Relatively Cheap Consumer Staples Play With Imperfect Profitability