Consumer cyclical: Assessing disruptions in restaurant, retail and travel

Changing consumer preferences and technological innovations have led to valuation shifts across different consumer cyclical industries.

R.J. Hottovy, CFA 7 July, 2015 | 5:00PM

Our consumer cyclical universe trades at an average price/fair value of 1.02 -- a shade below Morningstar's overall coverage universe at 1.03 -- suggesting that market valuations are generally aligned with our longer-term revenue growth and margin expansion forecasts. Although sentiment among affluent consumers appears relatively healthy, and we expect growth out of our discretionary names (albeit at a decelerating pace), we're monitoring spending among high-end consumers, which tend to take spending cues from asset and equity market valuations. A meaningful reversal in high-end spending would not only have an adverse impact on discretionary names, but it would also have implications across the broader consumer sector.

That being said, we've adopted a more balanced outlook for spending among lower- to middle-income consumers, acknowledging positives in the continued unemployment declines, general housing market improvements and lower gas prices but also negatives in real wage growth trends and elevated cost-of-living expenses such as rent, utilities and health care. We're more cautious about Europe consumer spending trends amid persistent unemployment but remain generally upbeat about the longer-term potential of China's middle-class through wage-driven wealth creation.

From a valuation perspective, one of the most intriguing categories is restaurants, with fast-casual chains such as Chipotle and Panera increasingly becoming disruptive forces for both traditional quick-service and casual-dining restaurant chains. In our view, fast-casual restaurants have adjusted better to changes in consumer behaviour during the past several years, including increased spending power among minority groups and millennials (which has created demand for a wider variety of flavours, better-for-you products and locally sourced food), evolving views about in-restaurant experiences (resulting in consumer calls for customizable menus and faster throughput) and widespread advances in consumer-facing technologies (leading to mobile-based ordering, payment and loyalty programs as well as in-restaurant wireless offerings).

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R.J. Hottovy, CFA

R.J. Hottovy, CFA  R.J. Hottovy, CFA, is a consumer strategist for Morningstar.