In Consumer Defensive Sector, Alcoholic Beverages Bear Most of the Buzz

The Morningstar US Consumer Defensive Index languished in the third quarter, in line with the overall market’s negative 3% return, as of September 27.

However, this more tempered appreciation hasn’t unlocked much in the way of attractive opportunities on which to stock up, and the consumer defensive sector trades at just 3% discount to our fair value estimates. For investors interested in the consumer defensive space, we’d point to alcoholic beverages, where shares trade at a 22% discount to our intrinsic valuations, and consumer packaged goods where more than one-third of our coverage trades in 4- or 5-star territory. We reckon investors’ reluctance to embrace shares in these niches is attributable to overweighting the persistence of supply chain constraints while underweighting efforts related to product innovation and brand prowess that ultimately conjure pricing power.

To be sure, supply chain constraints have served to upend stock at the shelf and compound cost pressures. In this context, the heightened demand that ensued since the pandemic took hold strangled the intermodal industry, given insufficient capacity and labor needed to boost volumes. While it appears some of these challenges could be subsiding, we aren’t blind to the fact that the pressure on freight capacity is real and other impediments could lead to greater disruption, as exemplified by the threat of rail strikes. We surmise any potential freight relief will still take time, but we think competitively-advantaged operators with negotiating prowess should navigate this volatile backdrop relatively unscathed.

Market Bests Consumer Defensive’s Modest Q3 gains.

Source: Morningstar Analysts

The Alcoholic Beverage Space Seems Particularly Attractive

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ource: Morningstar Analysts

Despite a Dearth of Undervalued Options, Favor To Be Found With Competitively Advantaged Consumer Defensive Firms

To blunt pronounced inflationary headwinds stemming from heightened input, labor, and freight costs, CPG firms raised prices to the tune of 12% in August against the previous year. But with an influx of strains on their pocketbooks, we think consumers may ultimately alter purchasing patterns by pursuing lower unit prices found in larger pack sizes (fewer trips to the store), opting for lower-priced private label, and/or defaulting to products with lower opening price points. To defend against this, we posit moaty firms will continue investing in consumer-valued innovation and marketing to enable products to win at the shelf.

Demand Normalization Could Relax Supply Chain Constraints

Source: IANA. St. Louis Federal Reserve. NielsenIQ USxAOC. Morningstar. Data as of Sept. 27, 2022.

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