Morningstar Advisor - Fall 2007 - 79

A number of wide-moat consumer stocks— such as Proctor & Gamble PG, Wal-Mart WMT, PepsiCo PEP, Coca-Cola KO, Walgreen WAG, Avon Products AVP, and Anheuser-Busch BUD—have been trading at attractive levels all year, improving the valuation data for consumer ETFs. To get their take on this sector and the stocks on their lists, I sat down with five of our equity analysts who cover consumer-goods stocks— Mitchell Corwin, Lauren DeSanto, Ann Gilpin, Matthew Reilly, and Greggory Warren. Sonya Morris: How economically sensitive are consumer-staples stocks? How much do they depend on the health of the U.S. consumer? Gregg Warren: The companies in the consumer-staples sector make mostly nondiscretionary items such as food, beverages, and household and personal products. As such, the demand for their products isn’t overly sensitive to economic swings. Matthew Reilly: These days, the American consumer is less important, since most big consumer companies sell their products internationally. It really is a global economy. So you could have a situation where the American consumer is doing well, but if another region falls on hard times, say emerging markets, profits could be squeezed. So we have to consider growth in consumer income—not just in the United States but across the globe. Lauren DeSanto: But these firms should be somewhat insulated from global economic shifts. These companies make products that people need, and consumers everywhere will turn to high-quality, name-brand producers such as Procter & Gamble and Coca-Cola. SM: How important is the international market to the outlook for these firms? Mitchell Corwin: Consumer-staples firms are mature in the United States, so their growth prospects here are somewhat muted. Plus, they face threats from U.S. retailers emphasizing their own private-label brands. So consumergoods companies can’t rely on the U.S. market to generate much growth. GW: These firms are definitely looking overseas to generate growth. With much of their current exposure in Europe, many of them are now looking to emerging markets, where the consumer is expected to gain more purchasing power. MR: When you think of growth, you have to think of the world. For many consumer firms, there’s no end in sight to continued international expansion. And for many consumer companies, if you are not already building a presence in emerging markets, it’s getting too late. The build-out of a distribution infrastructure is well on its way. SM: How does a consumer company earn a moat? MC: Through scale, both in market share and The Case for Consumer Staples Select Sector SPDR Morningstar ETFInvestor editor Sonya Morris likes the valuations of consumer staples so much she recently added a 10% stake in them to her Hands-On Portfolio, a portfolio she actively manages made up of ETFs that hold a large portion of stocks trading below their Morningstar fair value estimates. Morris selected Consumer Staples Selector Sector SPDR XLP because, for one reason, it is market-cap weighted, which is an advantage now because the best values can be found among the sector’s biggest names. Recently, 51% of its assets were dedicated to 4- and 5-star stocks, compared with just 33% for Rydex S&P Equal Weight Consumer Staples and 25% for PowerShares FTSE RAFI Consumer Goods, a fundamentally weighted ETF. Other factors that sealed the deal for her include: r Cheap expense ratio r Low price/fair value ratio and high average stock star rating. r Concentration in consumer blue chips that pay out healthy dividends and generate plenty of cash, meaning their stocks tend to be less volatile. distribution. Ann Gilpin: Brand is also important, but brand alone won’t give a company a moat. GW: And in order for brand to contribute to a moat, the company must invest in it. For MorningstarAdvisor.com 79

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Morningstar Advisor - Fall 2007

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