Heightened Uncertainty Gives Long-Term Investors Consumer Stocks to Feast On
Election results haven’t changed the cash flow prospects of our favorite names.
Despite the potential for near-term stock market volatility resulting from Donald Trump’s unexpected presidential victory, the longer-term impact is far from clear at this point. Overall, we think heightened uncertainty could create attractive buying opportunities for long-term investors interested in building a position in competitively advantaged global consumer names. Specifically, we believe the election results have not changed the longer-term cash flow profiles of narrow-moat Hanesbrands (HBI), wide-moat Procter & Gamble (PG), or wide-moat Starbucks (SBUX), all of which are trading at attractive discounts to our fair value estimates.
That being said, investors must be aware of short- and potentially longer-term changes across the broader consumer sector. First, while unlikely to be sustained, erratic changes in foreign currency rates are likely to have a near-term impact, particularly for firms with exposure to Mexico (with the peso trading at all-time lows against the U.S. dollar). This list includes Coca-Cola Femsa (KOF), with a 55% value share in soft drinks in Mexico, and Anheuser-Busch InBev (BUD), for which Mexico represents 7% of the business (including the recently acquired SABMiller assets). Additionally, we believe there could be several players in Mexico and Latin America more broadly that rely on heavy exports to the United States that could be negatively affected by new administration policies, including heavily amended or outright repeals of current trade agreements or changes in immigration policies, though the full impact is unlikely to be known for some time. Our initial take is that we don't expect policy changes to have a material impact on brand intangible assets for the players heavily exposed to Mexico, with cost structure changes minimized by the global footprint for most players operating in the region. As such, there could be several interesting names to keep on the radar screen.
One area of opportunity for potential investment ideas would be the alcoholic beverage category, as Mexican imports represent around 10% of the U.S. beer market and around two thirds of all U.S. beer imports. The category could be materially affected by higher trade tariffs, with possible shelf space loss to other imports and craft beer. Constellation Brands (STZ) (with 55% of revenue from exports from Mexico to the U.S.) would be hit hard by such a development. In addition, Diageo’s (DEO) outright acquisition of Don Julio tequila gives it some exposure to U.S./Mexico cross-border trade. Higher import tariffs could mean Diageo fails to achieve the double-digit volume growth it expected from Don Julio, which could prove particularly painful as Bushmills, the Irish whiskey asset it gave up for Don Julio, continues to prosper. As the impact on trade agreements for each of these names becomes more apparent, we will review our longer-term assumptions in greater detail. However, each of these companies offers sufficient channel and geographic diversity to withstand policy changes.
As Mexico’s second-largest chicken producer, no-moat Pilgrim's Pride (PPC) derives around 14% of its sales from the region. While we’ve thought the firm should benefit as the economy develops and consumption rises, we recognize that the market is structurally different from its U.S. counterpart (live birds account for about 30% of Mexican poultry sales and cut and value-added chicken constitutes less of the market), and pending changes to trade policy could ultimately have an impact on its financial prospects in the region. Despite this, we continue to believe that the higher margins that tend to characterize the firm's Mexican operation combined with Mexico’s affinity for dark meat (as opposed to its white meat-centric northern counterpart) should boost the economics of the region longer term while also reducing cut demand mismatches.
Outside Mexico, companies with high levels of manufacturing operations in China could be among those more immediately affected by the election results, given Trump's stance on existing trade agreements with China. While we've seen most of our consumer product companies diversify their manufacturing operations from China to India, other parts of Southeast Asia, and Latin America in recent years, some companies in our coverage universe still rely heavily on China manufacturing, including Adidas (ADDYY) and Nike (NKE), which source around one fourth to one third of their apparel and footwear offerings from the region. But we also acknowledge that the enactment of more comprehensive trade barriers in the region could favorably affect U.S. employment levels and/or position U.S.-based firms to reclaim share previously lost to Chinese imports. We think a reduction in imports from China could particularly stand to benefit home furnishing operators, toy manufacturers, and footwear firms, which have been disproportionately affected by Chinese imports. In this vein, we continue to believe that narrow-moat Williams-Sonoma (WSM) looks attractive.
Beyond trade agreement disruptions, we'll be closely watching to see what, if any, impact equity market volatility will have on consumers' perceptions of their own wealth (and potentially a recession in the U.S. and other global markets). Since the Great Recession of 2008-09, the U.S. economy has become more dependent on higher-income consumers. While this group has been able to withstand market corrections of greater than 10% a few times since the Great Recession (summer 2011, summer 2015, and early 2016), we believe the next several months may present a more significant test of consumption trends, and investors may need to temper near-term spending expectations, especially for categories like leisure and travel. That said, we don't expect these changes to be permanent, especially if lower tax rates are put into place.
R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.