Investors around the world, particularly in North America, got a rude awakening earlier this month as they got reacquainted with stock market volatility. After rallying to all-time highs earlier in the year, on Feb. 5 the Dow Jones and the S&P 500 indices tumbled more than 4%, while the NASDAQ swooned 3.7%, a rout that wiped US$4 trillion off world equities, as concerns of the U.S. Federal Reserve moving faster than expected to raise interest rates sparked the biggest sell-off in six years.
While equities will no doubt claw back the losses over time, the recent stock market rodeo is a yet another reminder of the vagaries of the stock market and why it is important for investors to hedge their portfolios against such precipitous drops. Indeed, this is as good a time as any for investors to consider adding to their portfolio stocks from relatively stable sectors. One such sector is consumer defensive. The non-cyclical defensive sector comprises companies whose performance is tied to essential goods, which makes these companies better at absorbing economic ups and downs, one of the key triggers for market volatility.
It's said that consumer defensive stocks, or consumer staples, are great for downside protection, but tend not to participate in bull runs all that much. That the sector returned more than 13% in the United States in 2017, according to S&P Dow Jones Indices, is evidence that these stocks can also play a part in portfolio growth when the markets are rallying, while serving as an effective bulwark against wild market gyrations.
The following consumer defensive stocks are trading well below their fair values and represent attractive buying opportunities, according to Morningstar equity research.
| Procter & Gamble Co. | ||
| Ticker: | PG | |
| Current yield: | 3.44% | |
| Forward P/E: | 19.0 | |
| Price: | US$79.40 | |
| Fair value: | US$98 | |
| Data as of Feb. 9, 2018 | ||
Procter & Gamble (PG) is the world's largest consumer product manufacturer. The company, which owns household brands including Tide, Charmin, Pantene and Pampers, generates 60% of its sales outside the U.S., with around one third coming from emerging markets.
Having culled 100 brands from its portfolio, the more nimble firm is now poised to benefit from a sharper focus on its highest return opportunities represented by the 65 remaining brands, of which 21 brands generate US$1 billion-US$10 billion in annual sales. "Recent results, which have included a return to low-single-digit sales growth, suggest it is beginning to realize the fruits from these efforts," says a Morningstar equity report.
In addition to sales gains, "P&G is looking to drive sustainable and profitable growth over the long term" says Morningstar sector director, Erin Lash, calling the move "prudent." To that effect, the company is working to realize US$10 billion in cost savings through reducing overhead, lowering material costs and increasing manufacturing productivity.
"As evidence of its cost edge, P&G increased core earnings at 4 times the level of sales in emerging markets in fiscal 2014, but 8 times sales over the past several years," says Lash, who recently upped the stock's fair value from US$96 to US$98.
However, instead of letting these savings fall to the bottom line, Lash says P&G will likely use these funds to strengthen its brand to boost sales, and bolster its entrenched retail relationships, which underpin its sustainable competitive advantage, or wide economic moat.
| Anheuser-Busch InBev SA/NV ADR | ||
| Ticker: | BUD | |
| Current yield: | 3.91% | |
| Forward P/E: | 20.6 | |
| Price: | US$102.61 | |
| Fair value: | US$126 | |
| Data as of Feb. 9, 2018 | ||
The largest brewer in the world, Anheuser-Busch InBev (BUD) owns five of the top 10 beer brands by sales and 18 brands with sales over US$1 billion. The firm holds a 62% stake in its Latin American subsidiary Ambev, and recently acquired the world's second largest brewer, SABMiller.
"Anheuser-Busch InBev has one of the widest economic moats in our consumer defensive coverage and is among the most efficient operators," says a Morningstar report. "Vast global scale and near-monopoly dominance in several Latin American markets give AB InBev significant fixed-cost leverage and pricing power, [and] a cost advantage that is likely to expand further following the acquisition of SABMiller."
This is instrumental in the firm's excess returns on invested capital and best-in-class operating and cash cycles, asset turnover ratios and working capital management. The firm's free cash flow conversion has been consistently higher than rivals in recent years, adds the report.
The acquisition of SABMiller could realize US$2.4 billion in cost savings, particularly in Europe and Latin America. However, it's the access to Africa that is "the crown jewel in the deal," says Philip Gorham, equity analysts at Morningstar. "The high-single-digit revenue growth generated in Africa will help offset" any weakness in other geographies.
While the firm is poised to grow revenue at 3.8%, it's expected to raise its earnings before interest and tax (EBIT) more aggressively, forecasts Gorham, who puts the stock's worth at US$126 per American Depository Receipt (ADR), implying 14 times adjusted enterprise value/EBITDA and a free cash flow yield of 5% for 2018.
| Mondelez International Inc. | ||
| Ticker: | MDLZ | |
| Current yield: | 1.92% | |
| Forward P/E: | 17.4 | |
| Price: | US$42.24 | |
| Fair value: | US$51 | |
| Data as of Feb. 9, 2018 | ||
Owners of well-known brands like Oreo, Chips Ahoy, Halls, Trident and Cadbury, Mondelez (MDLZ) is regarded as a stalwart in the global snack arena. Its portfolio consists of biscuits (41% of sales), chocolate (30%), gum/candy (15%), beverage (5.5%) and cheese and grocery (8.5%). The firm derives around one third of revenue from developing markets, nearly 40% from Europe, and about one fourth from North America.
The company's strong brand mix includes seven brands that each generate more than US$1 billion in annual sales, and it has an expansive global footprint, says a Morningstar report. A nearly 15% global share of the chocolate market, along with an industry-leading 18% global market share in the biscuit category, puts Mondelez in a prominent place in confectionary aisles, making it a valued partner for retailers.
The strength of the firm's competitive edge prompts Lash to forecast adjusted returns on invested capital to average around 16% over the next 10 years, "exceeding our 7% weighted average cost of capital estimate."
The company is also pushing hard to squeeze costs and "will ultimately be able to take out more than the US$1.5 billion in cost savings" through improving supply chain efficiencies and curbing unnecessary spending, says Lash, who pegs the stocks fair value at US$51.
The firm's fourth-quarter results show the new CEO Dirk Van de Put, after only two months on the job, has been able to grow organic sales by 2%, compared to 1.3% a year ago, and boost operating margin by 180 basis points to 15.9%, Lash points out.
| Campbell Soup Co. | ||
| Ticker: | CPB | |
| Current yield: | 3.12% | |
| Forward P/E: | 15.1 | |
| Price: | US$45.83 | |
| Fair value: | US$52 | |
| Data as of Feb. 9, 2018 | ||
The 140-year-old manufacturer of soups and convenience food products, Campbell Soup (CPB) owns well-known brands like Campbell's, Pace, Prego, Swanson and Pepperidge Farm. International operations account for around one fifth of Campbell's sales.
While the company is still dealing with the consequences of some missteps in the past and intense competitive pressures, its "dominant position in the U.S. soup category, combined with investments to reshape its portfolio (it recently acquired Snyder's-Lance's portfolio of on-trend snacks) should enable Campbell to generate solid cash flows and returns in the longer term," says a Morningstar equity report.
The firm's sustainable competitive advantage is built on intangible assets and a cost advantage. With a nearly 60% share of the U.S. soup aisle, "Campbell is a valued partner for retailers," says Lash, adding that the firm has resources to bring new products to market and promote them aggressively to drive customer traffic into stores, which "enhances the stickiness of its retailer relationships."
The strategic US$6 acquisition of Snyder's-Lance "materially strengthens Campbell's exposure to the faster-growing on-trend snack food aisle beyond its Pepperidge Farm lineup," notes Lash, adding that "consumers are snacking more, favouring the convenient, on-the-go products Snyder's-Lance sells."
As well, Snyder's-Lance's portfolio of health-oriented items are supportive of "Campbell's expansion in the natural and organic aisle [and] exposes it to attractive growth avenues," says Lash, who appraises the stock's worth at US$52, and projects high-teen operating margins, and 2% to 3% top-line growth over the next 10 years.
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