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Quarter-End Insights

Consumer Defensive: A Handful of Values in an Overheated Sector

Cost-cutting remains a focus amid continued slowing growth, but the sector is overvalued on the whole.

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  • The consumer defensive sector remains overvalued, trading at roughly a 6% premium to our fair value estimate. Macroeconomic uncertainty, low prevailing interest rates, and continued near-term cost-cutting opportunities have drawn investment in recent quarters, and we don't see a sizable margin of safety in the sector's current stock prices.
  • Kraft Heinz (KHC) in particular will likely further execute on near-term cost savings opportunities, but the market doesn't appreciate the impending headwinds that are likely to stall its margin expansion potential in the longer term, including a need to reinvest in brand and marketing expenses to remain competitive.
  • Investors looking for better growth prospects--without sacrificing solid fundamentals--should give ingredient suppliers a look. Despite the absence of branding or pricing power, ingredients companies often have just as good margins and returns on capital as branded consumer companies. They also provide protection from channel shifts that impinge on branded consumer companies by capturing growth from a variety of angles.
  • Given relatively low global growth opportunities, M&A activity in consumer defensive remains a core strategy, and the tie up between AB Inbev (BUD) and SABMiller (SBMRY) is on track to close in mid-October.

 

Adam Fleck does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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