Four safety stocks to steady your portfolio

The final quarter of the year has had a dreadful start with markets moving sharply lower last week. The slump wiped out the measly gains blue-chip stocks had made over the past one year. Worse yet, a slew of disappointing data -- slowing U.S. manufacturing activity, the trade war, interest rate uncertainty, signs of economic slowdown, contraction in corporate earnings -- suggests things may get worse before they get better.

The one-year returns for S&P 500 and Dow Jones indices are reflecting a loss of 0.50% and 2.3%, respectively, as of Oct 3. The recent swoon, coupled with growing fears of recession, may be a harbinger of deeper declines and panic selling. Prudent investors may want to position their portfolios defensively and look to add stocks that provide bigger value and a margin of safety.

The following high-quality names in the Morningstar coverage universe boast particularly attractive fundamentals for a time like this. They are significantly undervalued, represent durable businesses, and have ample unrealized upside indicating healthy future growth potential. Moreover, a ‘medium’ fair value uncertainty rating implies Morningstar analysts’ confidence in these stocks’ future cash flows. 

Ingredion (INGR) makes ingredients for the food, beverage, paper, and personal-care industries. Nearly half of sales are generated from starches, 35% are from sweeteners, and other products make up the rest. Value-added specialty ingredients account for roughly a quarter of sales, with commodity-grade ingredients accounting for the rest. Ingredion has a global footprint with more than 60% of sales outside the U.S., primarily from developing markets, including Latin America and Asia-Pacific.

The company’s products fall into two main categories: core ingredients (70% companywide sales and nearly 50% profit) and specialty ingredients. While core ingredients are “typically commodity-grade and provide no pricing power” for Ingredion, “specialty ingredients are value-added, requiring additional processing and, in many cases, proprietary formulations,” says a Morningstar equity report.

The specialty ingredients segment, with twice the gross margins and twice the sales growth of core ingredients, is the key profit driver. “Although we expect demand for Ingredion’s core ingredients to grow roughly in line with GDP in the regions where they are sold, specialty ingredients volumes should grow in the mid- to high-single digits,” says Morningstar equity analyst, Seth Goldstein.

The company has been investing heavily in its moaty specialty ingredients, “including plant-based proteins used in alternative meat products and specialty sweeteners,” adds Goldstein, who puts the stock’s fair value at US$125.

Capital One (COF) offers a wide range of financial products and services to consumers, small businesses, and commercial customers. The diversified lender specializes in three businesses: credit cards (42% of loans), consumer lending (31% of loans), and commercial banking (28%).

“While much of its success can be attributed to an unrelenting focus on technology, operations and organic growth, Capital One has periodically created significant value by acquiring businesses opportunistically and, most important, at attractive prices,” says a Morningstar equity report, noting that despite being one of the best-run banks, it does not receive the respect it deserves.

While the credit card segment still accounts for approximately 59% of income, Capital One has effectively used a strategic acquisition strategy to become a stronger, diversified consumer lender. “Investors focusing on near-term expenses are missing the value of these investments,” says Morningstar equity analyst, Eric Compton, stressing that, instead, “investors should be awarding Capital One for winning customers and building out its national banking franchise.”

Additionally, the bank’s focus on IT and data has turned it into a leader in measuring and forecasting consumer credit quality, customer behaviour, driving better credit performance and lower customer acquisition cost, says Compton, who recently revised the stock’s fair value from US$119 to US$133, prompted by cost savings measures bearing fruit.

Anheuser-Busch InBev (BUD) is the largest brewer in the world and one of the world's top five consumer product companies. The company’s portfolio contains five of the top 10 beer brands by sales and 18 brands with retail sales over US$1 billion.

The beer behemoth, whose portfolio includes Corona, Brahma, Beck’s and Budweiser brands, holds close to 70% market share in Brazil, the third-largest beer market in the world, and around half of the U.S. market, the world’s second largest.

The firm enjoys “one of the strongest cost advantages in our consumer defensive coverage and is among the most efficient operators,” says a Morningstar report.

A vast global scale and near-monopoly dominance in several emerging markets afford AB InBev significant fixed-cost leverage and pricing power in procurement. “This plays out in the firm’s excess returns on invested capital and best-in-class operating and cash cycles, asset turnover ratios, and working capital management,” says Morningstar sector director, Philip Gorham, pointing out “its free cash flow conversion has been consistently higher than peers in recent years.”

Acquisition of SABMiller provided InBev access to Africa where the company is expected to generate high-single-digit revenue growth, offsetting any declines in developed markets, adds Gorham, who estimates a US$118 fair value for the ADRs.

One of the world’s largest pharmaceutical firms, Pfizer (PFE) raked in US$50 billion last year selling healthcare products, chemicals, prescription drugs and vaccines. With a portfolio of many life-saving drugs that it sells globally, Pfizer generates close to 50% of its total sales from international markets, particularly emerging markets.

“Pfizer's foundation remains solid, based on strong cash flows generated from a basket of diverse drugs,” says a Morningstar equity report, noting that the company's large size underpins its significant competitive advantages in developing new drugs.

Apart from a large size and peer-leading economies of scale, Pfizer boasts significant financial resources and research power needed to support the development of new drugs. “This unmatched heft, combined with a broad portfolio of patent-protected drugs, has helped Pfizer build a wide economic moat around its business,” says Morningstar sector director, Damien Conover.

After struggling for years to launch new drugs, the pharma giant is now launching several potential blockbusters in cancer, heart disease, and immunology. “Pfizer’s patent-protected drugs carry strong pricing power that enables the firm to generate returns on invested capital in excess of its cost of capital,” says Conover, who puts the stock’s fair value at US$46.

Pfizer’s leading salesforces in emerging countries position the company to benefit from the dramatically increasing wealth in those geographies, he adds.