Consumer Defensive: Top-Shelf Picks for a Cautious Spending Environment

• The consumer defensive sector still trades roughly 1% above our fair value estimate, but we see a handful of undervalued industries and companies.
• Consolidation remains a theme in the consumer staples arena, with the Heinz-Kraft merger highlighting the opportunity for rationalizing brands and improving profitability.
• We believe companies in the defensive retail space build competitive advantages through pricing power and cost advantages; the market seems to be offering a discount for wide-moat  Wal-Mart (WMT).
• We don't think e-cigarettes present a substantial threat to tobacco companies' economic moats, because it could take 20 years for the product to gain full adoption, in our opinion. 

The consumer defensive sector trades at a median price/fair value of 1.01, although it is slightly less overvalued than our overall coverage universe, which trades at a median price/fair value of 1.03. Investment opportunities remain, but many of the stocks we consider the most undervalued are seeing severe foreign currency headwinds from the strong U.S. dollar (including top pick  Nestle (NSRGY)), threats to their growth from slowing international consumer spending (which has also plagued Nestle), or are going through fundamental business changes (such as  Procter & Gamble (PG)) that could continue to challenge these companies' revenue and earnings over the near term (albeit with the long run looking quite a bit rosier).