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Stock Strategist Industry Reports

Are Consumer Staples Stocks Reaching an Inflection Point?

Assessing valuations in the consumer staples industry following the recent stock price appreciation, renewed M&A speculation, and CAGNY 2013.

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The fact that consumer defensive names have been on a tear of late is hard to deny. Trading at an average price/value of 1.13 times, Morningstar's consumer staples coverage universe now trades at a meaningful premium to the average price/fair value of 1.06 for our full coverage universe. Consumer staples companies tend to be viewed as safe havens in uncertain economic landscapes--given the consistent cash flows and total shareholder returns (including dividend and share repurchases) that tend to characterize these firms--and the recent appreciation in the shares seems to support that stance. We believe the market's favor regarding names in this space also reflects the fact that the consumer defensive industry is one of the more concentrated categories with regard to economic moats (as roughly two thirds of the 100 consumer defensive companies we cover have either a wide or narrow economic moat), showing why these stocks are attractive in tough operating environments.

However, from our perspective, consumer defensive valuations are getting a little frothy these days. The Morningstar Consumer Defensive Index is trading at more than 16 times forward earnings, a premium relative to just a few short years ago (though still at a discount relative to the inflated market that characterized the dot-com boom at the beginning of the century). But, we contend that this figure understates the true multiple where the bulk of our moaty consumer defensive coverage universe trades, as the index also incorporates other less competitively advantaged sectors that don't warrant economic moats (and subsequently trade at more modest valuations)--such as grocery stores (which trade at a forward price/earnings multiple of 11 times), retail defensive (17 times), and education services (11 times). This compares with a forward earnings multiple of 20 times for the household and personal care sector, 21 times for alcoholic beverage companies, and 18 times for nonalcoholic beverage firms. Taking into account just the names within the beverages (alcoholic and nonalcoholic), foodservice distribution, household and personal care, packaged food, and tobacco categories, we believe the consumer defensive sector trades at a median forward price/earnings of 18 times and a forward enterprise value/EBITDA of 11 times--compared with historical multiples around 15 to 16 and 9 to 10 times--which appears a little rich compared with our implicit growth rates for these categories.

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Erin Lash has a position in the following securities mentioned above: PM. Find out about Morningstar’s editorial policies.