1. CONSUMER DESCRETIONARY SECTOR
Craig Babbert
Subu Balasubramanian
Dustin Beckel

2. BUSINESS CYCLE ANALYSIS
AGENDA
SECTOR OVERVIEW
BUSINESS CYCLE ANALYSIS
ECONOMIC ANALYSIS
FINANCIAL ANALYSIS
VALUATION ANALYSIS
RECOMMENDATION

3. SECTOR OVERVIEW OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
RECOMMENDATION

4. Sector Overview: Consumer Discretionary
What is Consumer Discretionary?
Goods and services that are considered non-essential by consumers but desirable if their available income is sufficient to purchase them.
Goods include durable goods, entertainment & leisure, apparel and automobiles
87 constituents with 5 industry groups
$4.38 trillion market cap
Represents 12.5% of S&P 500
Also considered “consumer cyclicals”
Rely heavily on business cycle and economic conditions
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5. Performance vs S&P 500 OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
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6. Performance vs S&P 500 OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
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7. Top Constituents in Consumer Discretionary Index
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8. BUSINESS CYCLE ANALYSIS
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9. Business Cycle Analysis
Demand vs Supply Side
Positives:
Low gasoline prices
Low inflation
Low interest rates
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10. Business Cycle Analysis
Threat of New Entrants - High
Bargaining Power of Buyers- High
Capital intensive for some
Economies of scale
Incumbent advantages
Branding power
Price sensitive buyers
Discretionary nature of goods & services
Multiple choices
Degree of Rivalry - High
Intense competition to gain customers
Innovation key
Price competition
Bargaining Power of Suppliers - Med
Threat of Substitutes - High
Porters 5 Forces
Threat of New Entrants
Much easier for retailers, online retailers, other niche players to enter the market. Very hard for capital intensive firms like automobile manufacturers, fast food chains
Advantage for incumbents (online maybe the exception) – solidified customer base
Niche areas are main entrance point for new firms
High power of branding
Economies of scale create price advantages
Bargaining Power of Buyers
Buyers are price sensitive
Several alternatives within each industry group (i.e. restaurants, leisure activities, retailers both online and brick/mortar)
Discretionary nature of spend brings buyer power up
Bargaining Power of Sellers
Union issues (auto)
Depends on consumer goods involved – how available are the inputs? Commodities?
Degree of Rivalry
Price competition
Innovation / trends key to success – companies must invest
Threat of Substitutes
Low switching costs
Medium loyalty (brand driven)
Discretionary goods – not needed for survival of consumer leads to waiting game/changing mind
Industry dependent
Union impacts (auto)
Input availability by industry
Low switching costs
Medium loyalty (brand driven)
Discretionary nature
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11. ECONOMIC ANALYSIS OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
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12. Consumer Discretionary
Consumer Discretionary : Factors Influencing Sector Performance
Consumer Discretionary
Inflation
Unemployment
Oil Price
GDP
Interest Rate
Exports
Consumer Confidence
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13. Impact of Interest Rates on Consumer Discretionary Sector Performance
Interest Rates and the performance of the Consumer Discretionary Sector are negatively correlated.
The increase in rates by the Fed in December is likely to cause some volatility in the sector, which will impact ROE negatively.
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14. Consumer Confidence vs Consumer Discretionary Sector Performance
The Consumer Confidence Index is a lagging indicator and a drop in Consumer Confidence has a direct impact on 5SCOND.
The Consumer Confidence Index has witnessed a steady recovery since 2009 and is expected to remain stable in the short term.
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15. Impact of Unemployment Rate on Consumer Discretionary Performance
Consumer Discretionary Sector performance has a high negative correlation to the unemployment rate.
As jobless claims continue to drop, the sector will continue to experience increased discretionary spending.
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16. US Total Exports vs Consumer Discretionary Performance
Typically Consumer Discretionary tends to expand when exports are strong.
However since a majority of the consumer discretionary companies in the S&P 500 are service oriented businesses focused on domestic consumption, the trend is not apparent.
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17. Oil Prices Correlation with Consumer Discretionary Sector Performance
Conventional wisdom states that Consumer Spending would expand as Oil Prices decline.
However data suggests that there is no direct correlation between the two metrics. Increase in Oil prices may lead to inflation causing a drop in consumer spending but the converse does not necessarily hold true.
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18. FINANCIAL ANALYSIS OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
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19. Cost of Capital : Consumer Discretionary
WACC Discount Rate
Rates
Implication for Investors
Risk Free Rate 4%
Low ~ Good for Investors
Cost of Debt 7%
Equity Risk Premium 5%
Debt Required Return of Debt
Required Return of Equity 9%
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20. Sales Growth : S & P 500 vs Consumer Discretionary
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21. Return on Equity : S & P 500 vs Consumer Discretionary
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22. Profit Margins: S & P 500 vs Consumer Discretionary
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23. VALUATION ANALYSIS OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION
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24. Consumer Discretionary Sector Vs. S&P 500
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25. Multiple Valuation Comparison (As of 10/22/16)
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26. SECTOR COMPARED TO S&P 500 YoY
One of the reasons for the expansion of the valuation metrics is due to the point in the business cycle. Future expectations for growth for Consumer discretionary companies was high during the expansion cycle and therefore led to higher P/Es (and compared to the S&P 500)
Per the forward-looking estimates, the valuation metrics appear to be decreasing relative to its history. This can be an indication that the market doesn’t expect much growth out of the sector and that we may be headed into contraction territory. There As mentioned previously, this could be due to a number of factors including the fed funds rate increasing and heading toward the end of the business cycle.
Don’t have a chart for it but some notables about P/E per sector; internet retailers had enormous P/Es, Hotels and travel were above average, and the others were around the average for the sector except for autos, which were lower than average.
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27. TECHNICAL ANAYSIS
Used the iShares Consumer Discretionary ETF (IXY) 5-year chart. Appears that the sector may have hit some resistance around the ~825 mark and the sector is near the top of its range. This could indicate some downward pressure. The 20, 50, and 200 day moving averages appear to say that the trend could continue upward. The other momentum indicators below suggest that the sector has some downward pressure that may continue short-term but then would be oversold indicating a reversal could come shortly after. Technical Analysis conclusion: more toward going long.
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28. RECOMMENDATION OVERVIEW BUSINESS ECONOMIC FINANCIAL VALUATION

29. OVERWEIGHT Stable jobs market Upcoming Interest Rate Increase
Business Cycle
RECOMMENDATION
OVERWEIGHT
In the short term (next couple of years) the sector should still be a strong sector. After that, the business cycle suggests that the sector should then be moved to an underweight rating.
Industry overweight: Auto. Good P/E, good earnings growth
Industry underweight: Hotel/Travel. High P/E
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30. QUESTIONS?