Consumer Defensive: Firms With an Edge Are Poised to Win

SECTOR OUTLOOK: Consumer defensive firms look to offset muted growth by beefing up their competitive positioning, and select opportunities for investors remain

Erin Lash, CFA 3 October, 2014 | 8:00AM
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While the consumer defensive space is far from trading at a bargain-basement valuation, we contend that pockets of value remain. Overall, the sector appears slightly overvalued, at a median price/fair value of 1.04, but we note that the fundamentals for this group tend to outperform during cyclical downturns because of the competitive edge these firms have amassed (as evidenced by the fact that approximately two thirds of them maintain a narrow or wide economic moat). As such, we recommend that investors looking to gain exposure to the space consider companies with established economic moats, or sustainable competitive advantage—those operating with structural supply chain and distribution advantages, economies of scale, sufficient resources to extend brand reach, and pricing power to withstand softness in volume growth.

Growth prospects remain bleak in mature, developed markets, highlighting the appeal of emerging regions for consumer product firms. We believe consumer staples companies with established economic moats can leverage their existing supply chain and distribution assets (to an extent) relative to smaller emerging-markets peers, have easier access to cheaper capital, can foster brand awareness and loyalty across multiple pricing tiers, and typically utilise sensible go-to-market strategies.

For investors looking for consumer staples names less reliant on a single economy that can withstand the economic shock from any particular region, Coca-Cola (KO), Diageo (DGE), Unilever (ULVR) and Philip Morris International (PM) may be attractive. With geographic diversification, there is a trade-off in reduced exposure to regions with faster-growing populations and higher disposable income potential that names like MaricoWuliangye Yibin and ITC offer. But Yum Brands (YUM), SABMiller (SAB) and United Breweries (CCU) offer both growth and diversification, as they've sufficiently broadened their geographic exposure while also establishing more concentrated positions in markets like China, Africa and Latin America, respectively.

Consumer product firms and retailers have long maintained an interdependent relationship, as retailers need brands to drive store traffic and brands need avenues for distribution. But retail industry consolidation has shifted some power away from consumer product firms over the past several years, and consolidation appears likely to persist.

Rivalry remains very high in the UK supermarket sector, as the resurgence of discounters Aldi and Lidl, as well as the emergence of high-end Waitrose stores, has left Tesco (TSCO) (and other traditional supermarket firms) stuck in the middle battling for share. We still think Tesco will remain a dominant player in the UK market and believe the shares are undervalued. However, Tesco shares are only suitable to investors who have long investment horizons and high risk tolerance.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Coca-Cola Co62.55 USD0.07Rating
Diageo PLC2,579.00 GBX0.17Rating
ITC Ltd Shs Dematerialised431.10 INR0.19
Marico Ltd Shs Dematerialsed619.05 INR1.35
Philip Morris International Inc102.20 USD0.22Rating
Tesco PLC310.20 GBX2.55Rating
Unilever PLC4,450.00 GBX0.79Rating
United Breweries Co Inc ADR11.68 USD-2.34
Wuliangye Yibin Co Ltd Class A135.68 CNY0.83Rating
Yum Brands Inc136.79 USD-0.88Rating

About Author

Erin Lash, CFA  Erin Lash, CFA, is a senior stock analyst with Morningstar.

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