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Quarter-End Insights

Consumer Defensive: Attractive Companies, Top-Shelf Valuations

Investor returns could suffer if growth slows and valuation multiples contract from lofty levels.

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  • Most names in the consumer defensive sector trade above our estimates of intrinsic value, and while some decent growth opportunities exist, we think that investor returns could suffer if growth slows and valuation multiples contract from lofty levels.
  • Defensive retailers could bolster competitive advantages in the organic/natural food space, but robust organic food growth could detract from consumer product firms' moats.
  • We think that firms with the most exposure to organic foods (such as  Kroger (KR) and  Whole Foods (WFM)) are overvalued at current levels, but we wouldn't be surprised to see more mergers and acquisitions among food manufacturers.

Many consumer defensive companies have economic moats because of pricing power and cost advantages, which give their management teams different levers to pull when challenges arise. These characteristics result in stable cash flow generation, which can be used to support dividend payments regardless of the economic backdrop. However, while these qualities are attractive, we do not believe that current valuations are as compelling. Most consumer defensive names trade at a premium to fair value; many firms are valued at peak multiples on peak margins, leaving more downside than upside in many cases, in our opinion.

Ken Perkins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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