Consumer defensive: Top-shelf picks for a cautious spending environment

As consumer spending slows, investors should focus on companies that enjoy strong brands or sustainable cost advantages.

Adam Fleck, CFA 7 July, 2015 | 5:00PM

The consumer defensive sector trades at a median price/fair value of 1.01, which is slightly less overvalued than our overall coverage universe, which trades at a median price/fair value of 1.03. Investment opportunities remain, but many of the stocks we consider the most undervalued are seeing severe foreign currency headwinds from the strong U.S. dollar (including top pick  Nestlé NSRGY), threats to their growth from slowing international consumer spending (which has also plagued Nestlé) or fundamental business changes (such as  Procter & Gamble PG) that could continue to challenge these companies' revenue and earnings over the near term (albeit with the long run looking quite a bit rosier).

Overall, we remain cautious on global consumer spending, particularly in emerging and developing markets, and generally recommend focusing on companies in the sector with narrow or wide moats that enjoy strong brand-related intangible assets or sustainable cost advantages.

The consumer staples industry also continues to consolidate, most recently with the announced tie-up of  Kraft (KRFT) and Heinz. Similar to previous deals private equity partner 3G has struck, we expect a fair amount of brand pruning as a result of this combination, along with substantial improvement in business efficiency (similar to the success Heinz has already realized--its EBITDA margins soared to 26% in fiscal 2014 from 18% in mid-2013). Although we don't believe Kraft's shares offer a sizable margin of safety for investors, we'd point to other opportunities in the space with significant internal-improvement opportunities such as the previously mentioned Procter & Gamble and  Mondelez (MDLZ).

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About Author

Adam Fleck, CFA

Adam Fleck, CFA  Adam Fleck is the regional director of equity research for Australia and New Zealand at Morningstar.