7 Undervalued Consumer Defensive Stocks

Stocks in the consumer defensive sector have had a rough go of it in recent months, part of a longer spell of poor performance during which these generally stable businesses have been hit by an unusual number of crosscurrents.

Chief among these currents are concerns about consumers tightening their belts and moving to lower-cost products, which would in turn pinch corporate margins and profits. But a new worry has arisen: the increasing availability of obesity drugs, their potential impact on consumer behavior, and how companies would respond to any resultant weakness in sales.

For long-term investors, this selloff has also left a number of big consumer defensive stocks trading in undervalued territory, according to Morningstar analysts. Among them are these names:

• Tyson Foods TSN
• The Estee Lauder Companies EL
• Conagra Brands CAG
• Kraft Heinz KHC
• Dollar General DG
• Campbell Soup CPB
• Kellanova K

Estee Lauder and Kraft Heinz are two of Morningstar analysts’ top consumer defensive picks. While undervalued, some of the other names are also facing near-term challenges.

Headwinds Slow Consumer Defensive Growth

The consumer defensive sector represents companies engaged in the manufacturing of food, beverages, household and personal products, packaging, or tobacco. Prominent names include Walmart WMT, PepsiCo PEP, and Costco Wholesale COST. The Morningstar US Consumer Defensive Index has seen a 9.7% drop over the past month three months through Oct. 31. Despite the sector’s defensive reputation, that performance is slightly worse than that of the broader market, which fell 9.2% over the same period as measured by the Morningstar US Market Index. Over the past year, consumer defensive stocks are down 3.8% while the stock market is up 7.6%.

Another significant industry within the consumer defensive sector is packaged goods. “There are a couple of factors that have weighed on the consumer packaged goods space more broadly,” says Erin Lash, director of consumer sector equity research for Morningstar Research Services. “For one, the strength of the consumer and questions surrounding how well volumes will hold up this quarter. To the extent that sales weaken, there is angst as it relates to how will firms respond. In this context, will we see firms lean on promotions to incite volumes—potentially aiding market shares but constraining profitability—or will firms continue to invest in research, development, and marketing to ensure their products stand out at the shelf?”

Lash says the group has also been hit by worries about potential ripples from the rise of obesity drugs such as Ozempic and Wegovy. “The worry is that if [these drugs] suppress appetites, that could have a broader-reaching effect.” However, “we don’t think they will have a material impact,” in part because of the limited supply, the small sliver of the population that is likely to take them, “and the “significant uncertainty as to insurance coverage, given their massive price tags.” Lash explains: “We believe these operators possess the resources to invest in innovation and marketing to continue adapting their offerings to align with consumer trends over time. At the current time, we don’t see this impacting volumes materially in the near term.”

Undervalued Consumer Defensive Stocks

To find undervalued stocks in this industry, we screened the Consumer Defensive Index for names with a Morningstar Rating of 5 stars.

Out of the 77 stocks in the index, Morningstar analysts cover 39. Of these, seven fit our screen as of Oct. 23, 2023. The most undervalued company on the list is Tyson, trading at a 46% discount to its fair value estimate. The least undervalued is Kellanova, trading at a 33% discount.

Undervalued Consumer Defensive Stocks

Tyson Foods

• Economic Moat: None
• Fair Value Estimate: $85.00

“Tyson primarily sells raw beef, pork, and chicken, although it has increased its exposure to prepared foods. Despite the scale it has amassed (with a sales base that exceeds $53 billion), meat is a commodity and carries little to no brand or pricing power, exposing sellers to volatility in both costs and revenue. Tyson’s strategy to sell three types of meat is intended to offer diversification, but diversification has its costs, and the headwinds of any one meat have weighed on companywide results at times. Additionally, we think there are limited revenue or cost synergies across different proteins.

“Tyson does carry some brand power in frozen processed poultry (for example, chicken nuggets), holding more than a third of the market compared with the mid-single-digit share for the next-largest competitor, Perdue Farms. Other familiar brands like Jimmy Dean and Hillshire Farm hold mid-single-digit shares in their respective markets, but so do many other brands. In all, the brand power Tyson does have in a few categories is far outweighed by the more commoditized products it sells.”

—Kristoffer Inton, equity strategist

The Estee Lauder Companies

• Economic Moat: Wide
• Fair Value Estimate: $200.00

“We believe Estée Lauder’s shares are attractive, trading at about half our fair value estimate. While a slow travel retail recovery in China has been impairing demand and margins, we don’t think this will affect the firm’s long-term prospects. We believe the company’s stepped-up brand investments and solid execution will help bring its margins back to historical levels while ensuring the firm’s standing (underpinned by category-leading brands and preferred vendor status) remains in place. With this and the premiumization trends, we think the firm’s stock will gravitate to our valuation over time.

“We have cut our fair value estimate to $200 from $249 to reflect a weaker-than-expected near-term outlook, given soft spending in high-margin skin care products amid macro headwinds and lingering inventory issues in Asian travel retail. We now forecast fiscal 2024 sales to be flat (down from a 6.5% increase previously). This reflects a 5% contraction in skincare sales (versus a 6% growth in our prior model), driven by weak demand in China and in travel retail, while sales of the other segments remain in place. Further, the lower sales, unfavorable mix, and higher costs associated with the new factory in Japan and a step-up in digital marketing resulted in a lowered fiscal 2024 EPS of $2.31 (from $3.75), which squares with the firm’s revised outlook. Even with this, we see an attractive upside in this deeply undervalued stock.”

—Dan Su, equity analyst

Conagra Brands

• Economic Moat: None
• Fair Value Estimate: $33.00

“After updating our forecasts and revising our long-term views, we cut our fair value estimate for Conagra to $33 per share from $46.50, mostly from a roughly 150-basis-point reduction in our midcycle operating margin forecast, as we expect competition to erode recent expansion. Even at our reduced fair value estimate, shares look undervalued, as we think the market is overweighting Conagra’s near-term volume challenges. As recent rapid price increases slow, we think consumers will return to more normalized buying patterns.

“We forecast sales to grow about 1% in 2024, as the tail end of inflation-related price increases offset the resulting volume declines. The near-term price increases should help the adjusted operating margin reach nearly 16.0%, up about 300 basis points and in line with management guidance of 16.0%-16.5%.

“In the longer view, Conagra’s targets include low-single-digit organic sales growth and mid- to high-teens adjusted operating margin. We forecast sales to grow about 2.3% per year after, mostly from volume growth. However, we expect margins to fall back to about 15% over the long term as the competitiveness in Conagra’s categories resumes and the firm no longer benefits from pandemic-induced sales growth or price increases.”

—Kristoffer Inton

Kraft Heinz

• Economic Moat: None
• Fair Value Estimate: $53.00

“We view shares as attractive, trading at a 40% discount to our intrinsic valuation while offering a 4%-plus dividend yield. Concerns abound surrounding the impact a weakening consumer spending environment amid an intensifying competitive landscape could have on Kraft Heinz and its peers. However, we don’t think such a backdrop will prompt the firm to chase near-term market share gains and see this angst as overblown.

“CEO Miguel Patricio and his team have judiciously prioritized debt paydown, with net leverage falling below its target of 3 times a year ahead of their plan. When combined with the company’s robust cash generation (free cash flow averaged in the midteens as a percentage of sales the last three years, which we think can hold over our forecast), we posit that this should unlock opportunities for enhanced financial flexibility to beef up its return to shareholders (in addition to investing in its existing operations), with our forecast calling for mid-single-digit increases in its annual dividend in short order.”

—Erin Lash, director of consumer sector equity research

Dollar General

• Economic Moat: Narrow
• Fair Value Estimate: $140.00

“We’ve lowered our fair value estimate for Dollar General to $140 per share from $179 due to a significant pullback in our profitability expectations for the next several years and a more subdued midcycle operating margin forecast of 8.2% (from 9.0%). However, we still think the stock, trading at around a 15% discount to our intrinsic valuation, offers an attractive risk/reward.

“With Dollar General’s core customer earning close to $40,000 per year and often relying on federal assistance, we expect the abatement of pandemic-induced fiscal stimulus to weigh on the top line—we forecast a low-single-digit decline in same-store sales in fiscal 2023 and 2024—and pressure margins from sales deleverage (a deviation from the more than 35% and 40% respective gains in sales and operating profits the past three years). Furthermore, Dollar General’s store base appears to be stretched thin, and recent investments to improve staffing levels and rectify concerns about working conditions are likely to weigh on the bottom line. Given the combination of sluggish growth and necessary investments at the store level, we forecast operating margins of 6.0%-7.0% over the next several years, a stark contrast to Dollar General’s 9.6% average margin during 2020-22.

“However, we still believe Dollar General enjoys a competitive edge, and we view its low-cost and convenience-driven value proposition as largely intact. The firm’s more than 19,000 small-box locations are positioned in thinly populated towns where competition is minimal, allowing the stores to serve as convenient fill-in shopping destinations for rural communities that lack an abundance of alternatives. Furthermore, Dollar General’s impressive store density prompts a cost advantage, in our view, as the firm can leverage its product delivery routes to fulfill the merchandising needs of numerous nearby locations—an element we believe is vital when operating in rural areas.”

—Noah Rohr, equity analyst

Campbell Soup

• Economic Moat: Wide
• Fair Value Estimate: $61.00

“CEO Mark Clouse’s tenure has been fraught with change since he joined in January 2019. The company parted ways with its fresh business and the bulk of its international operations while working to steady its core meals, beverages, and snacking arms. The COVID-19 pandemic and inflation have also had an impact. However, we don’t think recent performance is just a byproduct of increased consumer stock-ups of essential fare since March 2020. Rather, we think Campbell’s prudent strategic focus has set it on a sound course, leveraging technology, data insights, and artificial intelligence to bring consumer-valued products to the shelf in a timely fashion while also reducing complexity, investing in automation, and optimizing its supply chain and manufacturing network.

“In our view, Campbell has a wide economic moat resulting from brand intangible assets and a cost advantage. As such, we expect the firm’s returns on invested capital to remain above its cost of capital over the next 20 years. By operating as a leading packaged food manufacturer, Campbell is a valued partner for retailers, in our view, supporting its intangible asset moat source. Further, Campbell enhances the stickiness of its retailer relationships through the resources it maintains to bring new products to market and tout its fare to drive customer traffic. In our view, this positioning and its resources have enabled Campbell to maintain valuable shelf space for its offerings, even in areas like soup, where its share has been challenged by peers, lower-priced private-label fare, and smaller foes.”

—Erin Lash

Kellanova

• Economic Moat: Narrow
• Fair Value Estimate: $75.00

“Kellanova (the standalone global snacking operation of the former Kellogg business) possesses a stout portfolio, made up of a host of leading brands. Its top five—Pringles, Cheez-It, Eggo, Pop-Tarts, and Rice Krispies Treats—together account for around 50% of its sales mix.

“From our vantage point, the firm’s outsize exposure to the attractive snacking enclave (around 60% of total sales) and faster-growing emerging markets (30%, far above the low-single-digit marks its domestic packaged food peers boast) should aid its long-term growth prospects.

“We expect that the company will continue to prioritize reinvesting in its brands (in both consumer-valued innovation and marketing support) to ensure it remains a valued partner for retailers and wins with consumers, affording a brand intangible asset. Its narrow moat is also buoyed by a cost edge resulting from its expansive global distribution network, with 50% of its sales generated outside of its home turf. However, given the dearth of switching costs in the food space and its brand concentration, we lack confidence that this edge can hold for the 20 years necessary to warrant a wide moat, thus our narrow moat rating.”

—Erin Lash