32 More Defensive Bargains

U.S.-China trade tensions, a deepening of the inverted yield curve, and worries about global economic growth triggered stock market volatility again this past week.

After a similar bout of stock market whiplash a week ago, we shared some inexpensive stock ideas for investors who were looking to play a little defense.

Specifically, we homed in on stocks in Morningstar’s Defensive Super Sector, which includes the healthcare, consumer defensive, and utilities sectors--pockets of the market that are generally immune to economic cycles. We then narrowed the field further by screening for wide- and narrow-moat names within that Super Sector, ensuring that we were cherry-picking only the financially healthiest and profitable companies. We tossed out stocks with high or greater Morningstar Uncertainty ratings, thereby eliminating companies with less predictable cash flows. And lastly, we demanded that these defensive names be trading at 5-star levels--significantly below our fair value estimates. Just seven stocks made the cut.

This week, we’re continuing with the defensive theme but loosening our valuation standards a bit. We’re using the same screening criteria as last week, except we’re dipping down the valuation scale to stocks carrying 4-star ratings. These stocks don’t possess the same margin of safety as their 5-star counterparts, but they’re still trading below our fair value estimates, adjusted for uncertainty.

This time, 32 stocks made the list. Here’s a sector-by-sector look at these defensive names, as well as a deeper dive into one stock within each group.

Consumer Defensive The consumer defensive sector brims with familiar brands. These companies produce our comfort foods, brew our beers, and provide us with a place to buy those foods and that beer. We're unlikely to abandon the products that these companies make or the distributors who sell them, no matter the economic climate.

One of our analysts’ favorite stocks on the list is General Mills GIS. With a portfolio of recognizable brands that includes Cheerios, Haagen-Dazs, and Yoplait, General Mills has a firm footing with retailers who depend on its brands to drive store traffic, says analyst Sonia Vora. She expects these relationships to endure, thereby allowing the firm, with a Morningstar Economic Moat Rating of wide, to continue to generate returns on invested capital above its cost of capital--even in a bearish scenario--for the next two decades.

“While we continue to expect material competition from both branded and private-label fare in the consumer foods space, we now think General Mills' history of excess returns, despite top-line volatility, should allow the firm to bolster its investments in more attractive geographies and categories, like snacks and organics, to weather changing consumer trends,” adds Vora. The acquisition of Blue Buffalo (a natural pet-food firm) should bolster the firm’s top line, and targeted costs savings of $750 million per year should free up resources to significantly boost its brand spending.

This low uncertainty name is trading 15% below our fair value estimate as of this writing.

Healthcare It's no surprise that the healthcare sector is generally recession-resistant and considered defensive. After all, we continue to fill our prescriptions and visit doctors no matter what. Most of us value our health above almost anything else.

An analyst favorite in this sector is medical-device maker Medtronic MDT.

“Medtronic's standing as the largest pure-play medical device maker remains a force to be reckoned with in the med-tech landscape,” argues senior analyst Debbie Wang. “Pairing Medtronic's diversified product portfolio aimed at a wide range of chronic diseases with legacy Covidien's breadth of products for acute care in hospitals has bolstered Medtronic's position as a key partner for its hospital customers.”

We award Medtronic a wide economic moat because of its dominance in highly engineered medical devices to treat chronic diseases. Its intellectual property and nurtured relationships with physicians bolster its moat, says Wang. Moreover, the firm has slightly shifted its strategy toward partnering more closely with hospital clients with a greater breadth of products and services. Its diverse portfolio allows the firm’s waning product lines to be offset by growth in other areas, she concludes.

This medium uncertainty name is trading at a 17% discount to our fair value estimate as of this writing.

Utilities Our last defensive sector is utilities. We continue to need electricity, gas, and water whether the economy is expanding or contracting. Moreover, utilities' consistent dividends can be a source of comfort during periods of stock market uncertainty.

One of our top ideas here is Dominion Energy D--and it’s a familiar name to regular readers of Morningstar.com. We talk about it a lot because it’s a standout in many ways. For starters, it’s the only utility that earns a wide economic moat rating. It carries low uncertainty and a stable moat trend. It’s also managed by exemplary stewards of capital. And we think it has great growth prospects--and an attractive 4.88% dividend yield, to boot.

The company’s smart strategic pivot supports its wide economic moat.

“Since 2010, it has focused on the development of new wide-moat projects with conservative strategies, exited the exploration and production business, sold or retired no-moat merchant energy plants, and made significant investments in moaty utility infrastructure,” explains analyst Charles Fishman.

Annual dividend increases have averaged 9% the past five years; we expect the board to reduce dividend growth to low-single digits. But we still think the dividend yield and earnings growth could deliver low-double-digit returns through the next decade, concludes Fishman.

This low-uncertainty name is trading at a 10% discount to our fair value estimate as of this writing.