Consumer defensive: Not a lot to feast on

Consumer defensive names look rich, but a handful of firms remain undervalued.

Ken Perkins, CFA 5 July, 2016 | 5:00PM Erin Lash, CFA
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Valuations within the consumer defensive sector have remained elevated, trading at around a 4% premium to our fair value estimate. From our vantage point, this premium reflects a rotation into higher-quality names amid the uncertainty within the global macroeconomic landscape, along with investors' appetite for yield, the strong shareholder returns that characterize the sector and continued optimism for merger-and-acquisition activity in the space.

The first quarter of 2016 was challenging for many consumer companies; as expected, however, defensive firms delivered more stable results than many firms on the consumer cyclical side (especially apparel retailers). In general, organic revenue growth remains positive but relatively uninspiring across the consumer defensive landscape.

Although the consumer staples space tends to be fairly defensive in a more challenging market climate, global consumer spending, particularly in emerging markets, remains tepid. But beyond these pressures, we expect the pace of emerging-markets growth to exceed more developed markets in the longer term, given favourable demographic and disposable income trends. Given that most competitively advantaged firms in the sector are relatively mature (although some are benefiting from increasing exposure to emerging markets), we think market expectations for low- to mid-single-digit revenue growth are reasonable. We don't see many firms mispriced based on unrealistic revenue growth assumptions.

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Ken Perkins, CFA

Ken Perkins, CFA  Ken Perkins, CFA, is an equity analyst for Morningstar.

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