Consumer Defensives: Firms Prioritizing Innovation Should Adapt to Evolving Trends

The Morningstar US Consumer Defensive Index declined in the third quarter, underperforming the broader market’s gain. Within our coverage, the median stock is trading at a 6% discount to our intrinsic valuation, whereas Walmart and Costco pull the average above fair value.

Approximately 40% of names are rated 4 or 5 stars, indicating attractive long-term potential. The most compelling undervalued opportunities lie in the alcoholic beverages and consumer packaged goods subsectors, which trade at 27% and 16% discounts to our fair value estimates, respectively. We attribute this muted sentiment to persistent inflationary pressures and evolving trade policies, which continue to weigh on consumer confidence. Nevertheless, we believe firms that continue to invest in innovation are well-positioned not only to navigate this uncertain environment, but also to capitalize on emerging growth opportunities.

While consumers remain cautious amidst the economic malaise, grocery trips have not declined. In fact, Circana notes that shoppers are visiting stores more frequently but spending less per trip, with 30% buying on deals. However, this hasn’t manifested in outsize private-label sales gains. Instead, the US private-label share across a host of categories has remained relatively flat. In some categories, such as oral care, it has even declined by roughly 970 basis points to 6.5% over the past five years. The exceptions have been categories with limited brand differentiation, where consumers tend to make purchase decisions based on price, such as retail tissue. Private-label products now boast a 35.8% share, up from 32% prepandemic. However, we believe firms that continue to innovate and introduce differentiated products are well-positioned to grow, even in a challenging macro and competitive environment.

Accessibility remains a key driver of sales growth, with firms increasingly investing in omnichannel strategies. That said, e-commerce adoption has lagged in the sector, accounting for less than 20% of CPG and nonalcoholic beverage sales, with brick-and-mortar stores capturing the majority. Still, while digital capabilities may be more essential for discretionary categories, pandemic-driven shifts have pushed even consumer defensive brands to enhance their omnichannel strategies to stay visible across shopping touchpoints.

Top Consumer Defensive Sector Picks

Kraft Heinz

• Fair Value Estimate: $51.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

Narrow-moat Kraft Heinz KHC trades at a roughly 50% discount to our $51 fair value estimate and offers a 6% dividend yield, underscoring its long-term investment appeal. In early September, the firm announced plans to separate its sauces, spreads, and seasonings business from its North American grocery brands, creating two public companies by the end of 2026. Despite softening consumer sentiment, we expect both entities to pursue cost efficiencies to fund brand investments, particularly strategic initiatives in research, development, and marketing. We project these efforts will support 1%-3% top-line growth and 20%-21% operating margins over the next decade.

Campbell’s

• Fair Value Estimate: $62.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

Trading at a 45% discount to our $62 fair value estimate, Campbell’s CPB presents a compelling investment opportunity. Consumers have become more deliberate in their choices, with their preferences skewing towards healthier options and value, which is pressuring organic sales growth across the industry. Campbell’s aims to engage consumers in an intentional manner. As such, we expect ongoing innovation—around 5% of sales to R&D and marketing annually—and cost-saving initiatives to help the firm preserve its competitive edge and support our 2.7% 10-year average annual revenue growth forecast.

Freshpet

• Fair Value Estimate: $105.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating:
• Morningstar Uncertainty Rating:

No-moat Freshpet FRPT trades at a 48% discount to our $105 fair value estimate, offering an attractive entry point. Despite near-term headwinds, such as slower dog adoption and cautious spending, Freshpet’s unique fresh distribution and expanding store footprint position it well for growth. Furthermore, Freshpet is pursuing innovations in bag production that are driving higher-quality products at a lower cost, boosting profitability and reinforcing our 11.8% 10-year annual sales growth forecast. As such, we view the stock as a compelling long-term investment opportunity.