1. Consumer Staples Sector Laura Fillman Mary Kanet

2. Recommendation Under-weight Consumer Staples  Interim period between Federal Reserve action  Under-weight.50%, S&P 500 is at 9.46%  Consider under-weighting more when the economy gains momentum  Although there is uncertainty, the economy is expected to rebound, which would have a relatively negative effect on the consumer staples sector

3. Outline Sector Overview Business Analysis Financial Analysis Valuation Analysis Recommendation

4. Sector Overview

5. S&P 500 Composition Source: www.standardandpoors.com, as of 01/31/03www.standardandpoors.com

6. Consumer Staples Composition Source: Business Week Online, 01/31/03.

7. Consumer Staples Composition Largest Companies Procter & Gamble, 15.20% (Household Products) Coca-Cola, 13.65% (Soft Drinks) Altria Group, Inc., 10.84% (Tobacco)

8. Business Analysis

9. Demand Growth/Mature Life Cycle  Growth  More Competition  High Cash Flow Defensive Business Cycle  Stable performer  Performs better when market falls

10. Users and Geography  High Foreign Exposure Global Franchises for Coca-Cola and Procter & Gamble Declining dollar since the beginning of 2002  Emerging markets in Asia and Latin America

11. Trend line analysis  Given that consumer staples is a stable/defensive sector, we predict future demand to be consistent with past demand

12. Supply New capacity additions increase linearly with demand

13. Profitability and Pricing Ease of Entry  Difficult  Established companies  High brand recognition  Global presence  High initial investment

14. Strength of Customers  Widespread demand  Loyal to brand recognition  Increasing with global expansion Strength of Suppliers  Lower  Trying to maintain current customers

15. Competition  High  Pepsi vs. Coca-Cola  Very split Substitution  Moderate  Lower cost items  Not as much because of brand recognition  Inelastic demand for tobacco and alcohol

16. Financial Analysis

17. Current Revenues are $34,566 Growth rate is 4.1%

18. -Revenues have a growth rate of 14.5% -Current growth rate estimate is 16.0% -Total returns have a growth rate of 19.7%

19. -Revenues have a growth rate of 3.9% -Current growth rate estimate is 12.0% -Total returns have a growth rate of 13.6%

20. -Revenues have a growth rate of 3.0% -Current growth rate estimate is 10.0% -Total returns have a growth rate of 8.1%

21. -Revenues have a growth rate of 4.1% -Current growth rate estimate of 11.0% -Total Returns growth rate of 8.1%

22. -Profit margins have risen from 6.7% in December 2000 to 7.9% in September 2002. -Profit margins have risen as revenues have fallen, indicating cost- cutting activity within the sector. -Long-term estimated median growth rate is 10.8%.

23. -Margins (EBIT/Sales) have fluctuated between 8.5% and 13.2% over the last decade. Margins for 2001 were 10.97%. -Asset turnover (Sales/Assets) has fluctuated between 1.37 and 1.66 over the past decade. Turnover for 2001 was 1.41. -Reported ROE has fluctuated between 20.6% and 34.0% over the last decade. ROE for 2001 was 29.4%.

24. -Margins for the S&P 500 have been greater than those for consumer staples, however, the ROE has been less. Recall, ROE in 2001 for CS was 29.41%. For the S&P 500, ROE was 7.52% in 2001.

25. -Free cash flow after dividends has been positive during the past 5 years -The sector had a positive change in free cash flow during four of the past five years.

26. Price of consumer staples has generally been less relative to the S&P 500. It declines in expansion and grows in recession.

27. Valuation Analysis

28. Trends

29. Dividends (+) Dividends are providing a higher yield than the S&P 500

30. Earnings (-) Earnings are starting to dip as the economy starts to look promising

31. Earnings Estimates

32. Value relative to S&P 500 (-) P/E ratio is moving in the same direction as price and earnings. Earnings are starting to dip as well as the price, indicating that P/E will not be expanding in the future

33. Value relative to S&P 500 Net profit margin is decreasing as the P/S ratio decreases. Trend toward poor future performance

34. Momentum More selling activity than buying activity

35. Total Return Estimates

36. Valuation Summary + Dividends, Dividend yield is higher than S&P 500 and trends toward remaining that way - Earnings, Earnings growth is not as high as S&P 500 and is slowing - P/E ratios are declining, it is a signal of bad things to come, not more value Overall, the total return is too low, and will be worse with a strengthening economy

37. Growth rate estimate has decreased to 10.9%. The estimate has not fallen as much as the rest of the market, causing the upward trend line.

38. -Analysts have been recommending holding less consumer staples over the past year.

39. Recommendation Business  Cycle indicates that the sector will under perform due to the state of the economy Financial  Profit margins are increasing, revenues are decreasing, bad mix Valuation  Poor returns for Consumer Staples expected

40. Recommendation (cont’d.) Keep Consumer Staples under-weighted  Economy is still trying to rebound from recession Consumer staples do not perform well coming out of recession  Prices, earnings and net profit margins are trending downwards  Estimate revisions and selling activity indicate skepticism about consumer staples’ future performance