PBJ: This Food & Beverage ETF Just Got Way More Expensive

Investment Thesis

The purpose of this article is to recommend readers avoid the Invesco Dynamic Food & Beverage ETF (NYSEARCA:PBJ), a fund that traded at a sharp discount to the Consumer Staples Select Sector ETF (XLP) five months ago and, thus, had a nice margin of safety. However, that margin of safety has disappeared after PBJ’s quarterly reconstitution, and unfortunately, PBJ remains a relatively low-quality ETF. In fairness, other features improved, particularly its sales and earnings per share growth rate and the recent price momentum of current members. Still, against the backdrop of poor long-term results, PBJ is an ETF you should touch only when the odds are in your favor, and since that is not the case today, I have downgraded my rating to a “hold.” I look forward to explaining why in more detail below.

PBJ Overview

PBJ tracks the Dynamic Food & Beverage Intellidex Index, selecting securities based on price momentum, earnings momentum, quality, management action, and value. Under each category are metrics like return on assets, dividend yield, analyst estimate changes, valuation ratios, and growth rates. The Index provider doesn’t share the precise method, but it is comprehensive. Fortunately, Seeking Alpha has a system I’ve used to quickly identify PBJ’s strengths and weaknesses, and without a doubt, it’s quality, as measured by PBJ’s poor 7.31/10 profit score. Another consideration is how PBJ selects from all size segments, including those as small as SpartanNash (SPTN), which has a market capitalization of just $791 million. Naturally, this means giving up some of the downside protection Consumer Staples ETFs are known for.

PBJ’s track record since its June 2005 launch is not good. Its annualized 7.71% gain was 1.53% worse than XLP, translating to a 119.3% compounded deficit. The extra volatility and more significant drawdowns worsened matters, evidenced by its 34.22% drawdown from November 2007 to February 2009.

These results and the fund’s 0.57% expense ratio suggest PBJ is not a great long-term buy. However, I’ve had success applying a multi-factor approach since I began coverage. From my initial buy rating on January 26, 2022, to my downgrade on February 1, 2023, PBJ outperformed XLP by 5.50% on total returns. In the following six months until my August upgrade, PBJ underperformed by 2.21%, and now it’s outperformed again by 2.56%. If you’re willing to do some trading, it’s a good opportunity to generate alpha in an otherwise boring sector.

PBJ Analysis

Key Exposures

PBJ’s top ten holdings are below, which include Kraft Heinz (KHC), Constellation Brands (STZ), Monster Beverage (MNST), and Coca-Cola (KO). These holdings comprise 46% of the portfolio, so it’s a concentrated play, but that’s the case with most Consumer Staples ETFs. XLP’s top ten holdings total 68%, and the figure is 28% for the Invesco S&P 500 Equal Weight Consumer Staples ETF (RSPS). There are only about 135 U.S. Consumer Staples stocks, and PBJ reconstitutes quarterly to select 30 based on its proprietary model.

Worth noting is that PBJ isn’t entirely Consumer Staples. It also includes 13% allocated to Consumer Discretionary, with the GICS sub-industry breakdown as follows:

• Packaged Foods & Meats: 28.65%
• Soft Drink & Non-Alcoholic Beverages: 18.08%
• Restaurants: 13.44%
• Agricultural Products & Services: 9.64%
• Food Retail: 8.36%
• Food Distributors: 8.15%
• Brewers: 5.43%
• Distillers & Vintners: 5.16%
• Personal Care Products: 3.08%

Fundamentals By Company

The following table highlights selected fundamental metrics for PBJ’s top 25 holdings, totaling 88% of the portfolio. This gives us clues as to how the Intellidex model works and, specifically, how much quality it gives up to score well on other factors.

I’ll start with some bad news. As mentioned earlier, PBJ’s 7.31/10 profit score is poor. Backed by 8.55% net margins that decrease as we go down the list, it’s clear the most profitable companies are assigned a greater weight. The problem is a lot of “junk” at the bottom of the list. Certain stocks like Dole (DOLE) have tight gross profit margins below 10%, meaning their net profit margins are even lower. That’s the nature of many food and beverage businesses, but the average profit score for the Packaged Foods & Meats sub-industry is 5.30/10, and Dole’s is 3.25/10 (“D+” Grade).

The good news is that these companies offer something in return, particularly good momentum. PBJ’s constituents are up 19.74% in price over the last year compared to 0.88%. While PBJ hasn’t held the same stocks for the whole year, this illustrates how the selection process works. The Index assigns a high weight to stocks with strong recent price momentum, hoping there’s some outperformance left. There’s empirical evidence to support this and why Seeking Alpha’s Quant System double weighs the momentum factor.

Strong price momentum is valuable, and it’s a bonus when backed by actual data and not speculation. In this case, that data is the improvement in Wall Street analyst earnings changes, as measured by PBJ’s 7.25/10 EPS Revision Score. That’s better than XLP’s 6.70/10, which itself is the third-best large-cap sector behind Materials (7.09/10) and Communication Services (7.01/10). I see this as a positive development for the industry, and I anticipate investors seeking some safety, considering earnings surprises for S&P 500 stocks are well below their five-year average. Per FactSet:

In aggregate, companies are reporting earnings that are 9.8% below expectations. This surprise percentage is below the 1-year average (+5.7%), below the 5-year average (+8.5%), and below the 10-year average (+6.7%).

PBJ also offers much better historical sales growth, estimated sales growth, and estimated earnings per share growth rates than XLP. In particular, EPS growth is 13.09%, and only four stocks, including Dole, have negative expected earnings growth. However, the downside is that PBJ trades at 24.00x forward earnings, slightly more expensive than XLP’s 23.69x and different from the discounted setup in August (18.88x vs. 23.80x). In effect, the margin of safety has disappeared, and shareholders are relying on PBJ’s growth and momentum features to drive performance.

Investment Recommendation

PBJ looks solid from a growth and momentum perspective but needs better quality and valuation features. This differs from my August review, where quality was the primary concern. A steep valuation discount is required because, based on PBJ’s poor long-term results, its strategy doesn’t work. Therefore, I’ve downgraded PBJ to a “hold,” but I look forward to re-evaluating after the subsequent Index reconstitution. Thank you for reading.