4 Consumer Stocks in the Bargain Bin

The consumer cyclical sector hasn't had a stellar year. Though it has managed to eke out a gain of 2.7% over the year to date through Sept. 12, it's the second-worst-performing stock sector, beating only healthcare. In the past four weeks, it slid 2.2%.

Though it's hard to pinpoint the specific headwinds facing the wide-ranging sector, there are some broad themes affecting the companies we highlight below. For one, consumer spending on apparel has been weak. Also, of course, many retailers have felt major pressure from Amazon, which continues to disrupt the traditional brick-and-mortar retail model; without the cost burden of physical stores,

Though it has been dogged in recent weeks, the consumer cyclical sector still isn't exactly cheap--at 0.97, it's trading at a modest discount to the average stock in our global coverage universe, at 1.01. Nonetheless, there are some bargains to be found here. To unearth some, we screened for stocks on our coverage list that are rated 5 stars, which indicates that we think they are undervalued relative to our estimate of their fair value. We then excluded companies with a fair value uncertainty rating of very high or extreme; we believe it's very difficult to estimate the fair value of such companies because we aren't as confident about estimating the stock's future cash flows. Finally, three of the stocks we highlight have an economic moat rating of narrow, which means we think they have advantages that will fend off competitors for 10 years, but we did include one pick with no moat because it was selling at an attractive valuation.

As of Sept. 13, eight stocks passed the screen. Morningstar Premium Members can click

to see the full screen results. Here are four of our best ideas.

Bed Bath & Beyond

BBBY

Price/Fair Value 0.67 Fair Value Uncertainty: Medium Economic Moat Rating: None

Morningstar equity analyst Jaime Katz cut Bed Bath's fair value estimate in June after the company's first-quarter results left its competitive positioning in question. Specifically, the physical store-based home retailing business continues to experience pressure from online peers such as Amazon that can undercut in price and speed and offer a more user-friendly mobile or web experience, Katz said. However, Bed Bath still has a lot going for it, in Katz's opinion: It has a best-in-class decentralized merchandising strategy, untapped international growth opportunities, and widely recognized retail brands like the namesake Bed Bath & Beyond, Buybuy Baby, Harmon, and Cost Plus World Market concepts. We do not believe Bed Bath & Beyond has an economic moat, given the brand's limited pricing power, nonexistent consumer switching costs, and unsustainable cost advantages (such as higher and more frequent coupon redemptions and costly free shipping). And though competition from mass merchants and online retailers will likely remain a headwind, Katz points out that the company should continue to benefit from rising housing market prices.

Williams-Sonoma

WSM

Price/Fair Value 0.67 Fair Value Uncertainty: Medium Economic Moat Rating: Narrow

Katz thinks Williams-Sonoma has carved out a solid niche in the fragmented $104 billion domestic home furnishing market: Its brand intangible asset (the company owns Pottery Barn, PBkids, PBteen, and West Elm as well as its namesake brand) has historically supported the firm's top- and bottom-line growth. Its ability to drive repeat business is reliant on customer loyalty and smart marketing and merchandising, Katz points out. She also believes that Williams-Sonoma distinguishes itself through its access to some of the best analytics in retail, which in turn allows the company to operate more efficiently, market more effectively, and turn inventory faster than its peers. Though we did modestly lower our fair value estimate at the end of August after the company reduced its outlook modestly for the remainder of 2016, Katz believes demand for Williams-Sonoma's brands will continue to be supported by housing and demographic trends. In addition, global expansion could help improve sourcing and distribution costs longer term, which would ultimately improve operating margins, Katz said.

Norwegian Cruise Line Holdings

NCLH

Price/Fair Value 0.57 Fair Value Uncertainty: High Economic Moat Rating: Narrow

We modestly lowered our fair value estimate for Norwegian Cruise Lines after the company reduced its outlook for the rest of 2016 and also 2017, citing a weaker British pound after Brexit and weakness among Americans booking European cruises. (But, Katz said, the cruise line's Alaska, Bermuda, and Balkan routes remain solid.) Norwegian is relatively smaller than its North American cruise peers, such as Royal Caribbean and Carnival; therefore, it has significant global capacity growth potential over the next five years. In addition, Katz thinks Norwegian's freestyle cruising is a differentiated product that caters well to cross-generational travelers, allowing families to travel together. With double-digit earnings growth projected over the next five years and shares trading below $40 and at 10 times 2017 earnings (around $4), Katz believes the shares are currently undervalued.

Hanesbrands

HBI

Price/Fair Value 0.67 Fair Value Uncertainty: Medium Economic Moat Rating: Narrow

As Morningstar senior equity analyst Bridget Weishaar explains in this recent video, Hanesbrands is our top pick in the apparel segment. Hanesbrands has traded down along with other apparel-makers, who have been dogged by issues such as weakness in clothing sales and declining foot traffic in stores. However, Weishaar feels that's unjustified. Hanes is primarily in a replenishment category, as a large segment of its business is in undergarments and basic apparel, which is a space where customers value comfort, fit, and consistency over price. Further, Weishaar notes, Hanesbrands leverages extensive manufacturing capabilities to produce quality products and charge an economical price; these manufacturing capabilities also allow Hanes to deliver high returns on acquisitions. Weishaar notes that through acquisitions, Hanesbrands has increased operating profit by $120 million but then added $170 million in synergies; she thinks acquisitions will be a core driver of returns for shareholders going forward.