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Consumer Defensive: Some Industries Are Showing Resistance to E-Commerce Threat

Tobacco and alcohol firms are trading below our fair value estimates.

The consumer defensive sector has lagged market performance this quarter through Dec. 5, returning 3.8% compared with the market's returns of 9.0% (Exhibit 1).

The consumer defensive sector performance has cooled. - source: Morningstar

When taken together, we view the consumer defensive sector as overvalued, with the median stock trading at an 8% premium to our fair value estimates. Within the sector, we consider retail defensive overvalued, trading at a 20% premium to our assessment of intrinsic value. However, we see opportunities in tobacco and alcoholic beverages, which in the aggregate trade 14% and 10%, respectively, below our valuations.

With the sector overvalued in aggregate, tobacco looks attractive. - source: Morningstar

We think the digital channel remains an area of opportunity for consumer goods firms, as e-commerce penetration has been steadily increasing over the past decade. Retail spending through e-commerce grew 17.3% for the third quarter of 2019, far surpassing the 4.4% growth in total retail spending (Exhibit 3). While this channel has helped lower the barriers to entry for niche competitors, particularly by reducing the need to secure shelf space at brick-and-mortar retailers, firms that keep investing in their brands should be able to defend against competition, both in-store and online.

Growth in e-commerce has far surpassed total retail spending. - source: Morningstar

This shift to online shopping has not only caused disruption for manufacturers, but also retailers with a large brick-and-mortar presence. However, some retail segments are more resistant to this trend. As an example, we think the discount/dollar stores and off-price apparel sellers can withstand this threat, given their focus on convenience and small formats for the former and the hard-to-digitize treasure hunt for the latter. Discount/dollar stores tend to target lower-income customers, with 30% of customer households earning under $25,000 a year (for Dollar General specifically, but which we believe is a proxy for the space; Exhibit 4). These customers often must minimize absolute dollar costs, leading to repeat visits for smaller packaged necessities that can carry higher retailer margins, but would be costly to ship if ordered online.

A lower-income cohort limits the e-commerce threat at dollar stores. - source: Morningstar

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