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Stock Picks from Morningstar Analysts

A trio of Morningstar analysts share their outlooks for and opportunities in the healthcare, consumer, and basic materials sectors.

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This analyst blog is part of our coverage of the 2016 Morningstar Investment Conference. 

On Tuesday afternoon at the Morningstar Investment Conference, Morningstar analysts Damien Conover, R.J. Hottovy, and Dan Rohr talked about expectations for their respective sectors, and shared some best ideas.

Conover, who overseas Morningstar's healthcare sector research, says that healthcare names are among the most undervalued stocks today. (According to Morningstar's Market Fair Value Graph, the median healthcare stock in our coverage universe is 7% undervalued as of this writing.) Rising healthcare costs--and Washington's threats to overhaul them--have proven a turnoff for investors. While Conover calls costs "a valid concern," he argues that the massive influx of innovation during the past few years more than outweighs any risks from Washington.

Sources of moat in this sector are based mostly on intangible assets that accompany innovative companies. One of Conover's favorite innovators is wide-moat  Biogen (BIIB); while many investors are concerned about the firm's multiple sclerosis franchise, Conover thinks its neurology-focused pipeline will drive future results. Narrow-moat  Vertex Pharmaceuticals (VRTX), which maintains a dominant position in the cystic fibrosis market, is another undervalued innovator that Conover is keen on. In a few instances, such as with wide-moat  Express Scripts (ESRX), cost advantage is a source of moat. Conover says this pharmacy benefits manager's escalating dispute with  Anthem (ANTM) is clouding the market's view of the company. And lastly, Conover named  Sanofi (SNY) as a way to play growing healthcare sales in China. He thinks the company's vaccines, insulins, and consumer products portfolios are a good fit for China's consumer base.

Consumer strategist Hottovy notes that consumer stocks are a mixed bag. As a group, consumer cyclical stocks are undervalued while consumer defensive stocks are overvalued. In particular, Hottovy likes a number of global e-commerce giants, adding that once an ecommerce platform has 10% to 15% of a given population on its platform, it's tough for competitors to make headway. These stocks therefore establish moats. He likes wide-moat  Amazon (AMZN) and  Alibaba (BABA) , as well as narrow-moat  MercadoLibre (MELI). All three are currently trading at fair value and are therefore ideas for a watch list.

Hottovy also expects Chinese consumption to be "huge" for some consumer stocks. In particular, he he's optimistic about companies whose products and services appeal to lower- to middle-income consumers. Stocks levered to this idea include aforementioned Alibaba and wide-moat  Yum Brands (YUM).

Finally, Hottovy thinks some of the best values in the consumer sector can be found among downtrodden apparel manufacturers, such as wide-moat  VF (VFC) and  Hanesbrands (HBI). Hottovy notes that these companies are channel agnostic; as such, channel shift isn't a risk here, as it is with some retailers. He therefore thinks these names are being unduly punished in the market.

Basic materials specialist Dan Rohr notes that his slice of the market is pricey: the median basic materials stock under coverage is 13% overvalued. Rohr says China is the single most important driver of growth in the sector: "As goes China, so go these companies." Rohr expect China's market to grow at 1.5% to 4.5% over next decade, well below the rates it enjoyed during the "boom."

Companies in this sector generally earn moats by being low-cost producers, in a relative sense. And relative cost is dependent on demand. If demand is weak, prices will be weak, and the spread between the company's price and its cost won't be wide enough to create sufficient excess profits, said Rohr. Given his China view, moats in this sector are currently few and far between. For example,  Freeport-McMoRan (FCX) is a low cost producer. But in an environment of $2 copper, the company can't out-earn its cost of capital, says Rohr. It therefore doesn't earn a moat.

One bright spot for Rohr: U.S. housing. He's optimistic on housing starts--and therefore bullish on lumber prices. Rohr's pick here is  Canfor (CFP). The stock is trading in 5-star range.

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