The consumer defensive sector continued to lag the broader market in the third quarter, chalking up a 1.0% gain, nearly 220 basis points less than the market’s 3.2% appreciation.
Exhibit 1: Consumer Defensive Gains Once Again Lagged the Broader Market
Despite this, we still don’t view the space as flush with bargains, with the median consumer defensive stock trading at neither a premium nor a discount to our assessment of intrinsic valuation, though this is more attractive relative to the 8% premium the sector traded at in June. And in this context, more than one fifth of our consumer defensive coverage now trades in 4- or 5-star territory (up from just 12.5% three months ago), two thirds of which reside in the consumer packaged goods realm. While CPG manufacturers have benefited from consumers staying closer to home since March 2020, we surmise the market underappreciates the extent to which operators were investing to boast profitable top-line growth before COVID-19 took hold.
Exhibit 2: Within the Sector, we See Value in Consumer Packaged Goods
However, CPG operators aren’t immune to headwinds, which have most recently included a rash of supply chain constraints, similar to those being felt by operators across a vast array of industries. In our view, this is reflective of continued robust demand combined with challenges amassing supply, which is inhibiting manufacturers’ ability to get products to shelves. This has manifested in decreased CPG promotional spending, as illustrated by the IRI CPG Promotional Index, where a reading of less than 100 showcases declining promotions. While we don’t anticipate competitive intensity will subside, we still view leading branded operators with pricing power as the best positioned to navigate these challenges, using their resources to further entrench their positions with retail partners.
Exhibit 3: CPG Operators Have Begun Dialing Back Promotional Spending
And as COVID-19 cases have surged in select geographies, consumers have again resorted to e-commerce for packaged food, household, and personal-care offerings. In our view, the pandemic jumpstarted consumers’ acceptance of purchasing such fare online, and investments to enhance a retailers’ digital infrastructure over the last several years has afforded the opportunity to meet this demand. We surmise that retailers that differentiate their experiences and offer convenient omnichannel options stand to retain the shoppers they've gained since the pandemic began.
Exhibit 4: As COVID Cases Rise, Consumers Hit Up the E-Commerce Channel for Groceries
Kellogg K Star Rating: ★★★★ Economic Moat Rating: Wide Fair Value Estimate: $83 Fair Value Uncertainty: Medium
At a 23% discount to our valuation, we think investors should consider wide-moat Kellogg. Years before COVID-19 came on the scene, Kellogg started taking steps to alter its mix toward more attractive areas (from a category and geographic perspective), which we believe the market fails to appreciate. More specifically, over the past decade, Kellogg has shifted its product mix away from the mature cereal aisle toward on-trend snacking. In addition, this wide-moat operator has pursued inorganic ways to build out its reach in faster-growing emerging markets, which now account for more than 20% of its sales base.
Boston Beer SAM Star Rating: ★★★★ Economic Moat Rating: Narrow Fair Value Estimate: $750 Fair Value Uncertainty: Medium
Shares of narrow-moat Boston Beer, a leader in U.S. high-end malt beverage and adjacent categories, trade about 30% below our intrinsic valuation. The firm has benefited from being a first mover in the latest growth trends and has been able to capture disproportionate market share. While seltzer trends have recently slowed, we think Boston Beer’s sales will continue to be supported by secular consumption shifts (such as the desire for a low-sugar footprint and varied flavor profiles, and as evidenced by the recent launch of the malt cocktail Bevy Long Drink).
Conagra Brands CAG Star Rating: ★★★★ Economic Moat Rating: None Fair Value Estimate: $41.50 Fair Value Uncertainty: Medium
We consider no-moat Conagra an attractive investment, with shares trading about 20% below our fair value estimate. We think investors fail to appreciate how the Conagra Way strategy is improving growth and profit margins. Conagra has significantly reshaped its portfolio, while also enhancing the effectiveness of its innovations and the efficiency of its marketing investments by shifting from traditional mediums, to digital, which are more relevant. In addition, Conagra has identified over $1 billion in cost savings, which we think will result in 19% operating margins over the long term, up from fiscal 2020’s 16.5%.