Morningstar Advisor - April/May 2013 - (Page 32)

Sector Rap been focused on driving additional costs out of the business. Volatile food costs, lumpy restaurant traffic, and the fact that the restructuring effort is taking longer and costing slightly more than anticipated are all issues weighing on the stock. But we think management is appropriately investing for the long term. In addition, the dividend is yielding around 3.5%, making it attractive for income investors. Ken Perkins: I cover meat processors. The smaller-cap companies, such as Hormel Foods HRL, Hillshire Brands HSH, and Tyson Foods TSN, are slightly overvalued. They’re facing some pretty significant commodity cost headwinds as a result of the drought. But we think that of the three, Hormel is probably the most attractively priced. They’re a good manager of brands, and that’s allowed them to manage some of the commodity-cost pressures better than their peers have. They’ve also just acquired the Skippy brand, which opens the doors to China and should allow the company to leverage its Spam distribution in the region. So even though these companies have lower dividend yields than their larger counterparts, their international growth opportunities could allow them to increase their dividends at an above-average rate. Hottovy: That raises an important point, which Thomas also alluded to earlier. One of the key themes at the analyst conference was the idea of innovation in emerging markets. An attractive feature of the consumer defensive space is that it offers emerging-markets exposure. A lot of these companies have been in emerging markets for decades. They have built up established operations. markets get more money in their pockets through GDP growth, they will buy more and more packaged beverages and packaged foods. We expect that the emerging regions of Latin America, Africa, and Asia will be a major driver of not just Coca-Cola’s growth but also Pepsi’s for its snacks business, and Philip Morris’ for its cigarette and tobacco business. Lash: Within the household and personal-care and packaged-food firms, we have two different setups. There are consumer product companies that are almost exclusively focused on the U.S. market. Church & Dwight CHD, Clorox CLX, and ConAgra CAG come to mind. But several of the packaged-food and household and personal-care names that we cover maintain a sizeable presence in emerging markets. Colgate-Palmolive CL and Unilever UL both derive more than 50% of their sales from faster-growing emerging markets. They have been in those markets for a significant period of time, which gives them the benefit of understanding the local consumer and the routes to market—the sales and distribution platforms that are necessary in those markets. These are huge advantages. We’ve also seen several companies in the space look to expand their footprint in emerging markets of late, primarily through acquisitions and joint ventures. For example, two years ago General Mills GIS acquired Yoki Alimentos, a Brazilian consumer products firm. HJ Heinz HNZ has made deals in China and Brazil over the past couple of years. We expect this trend to continue, because tastes and preferences vary around the world. Guziec: What could derail this emergingmarkets story? What are the risks there? Mullarkey: If you look at a company such as Coca-Cola, emerging markets are going to be the driver of growth. In the United States, the average person consumes 400 8-ounce servings of Coca-Cola beverages each year. This compares with just approximately 40 servings per capita in China and less than 15 servings per capita in India. As consumers in emerging 32 Morningstar Advisor April/May 2013 Hottovy: At the end of the day, emerging markets are still heavily dependent on developed markets. They’re typically trade partners. If we continue to see pressure in the European markets, or if we see a retrenchment in the U.S. economy and a decrease in demand in developed markets, it could have a trickle-down effect on emerging markets. These countries are the producers of a lot of these products, and a lack of demand would weigh on the spending power there. It’s one critical risk as we look at 2013 and beyond, although we’re comfortable saying now that we’ll see growth in the mid-singledigits, and possibly see high-single-digit operating-income growth for a lot of consumer staples companies this year. Mullarkey: Emerging markets also are more subject to political instability. For example, during the Arab Spring, consumer-packagedgoods companies saw their sales decline for beverages and tobacco in parts of North Africa. When countries such as Syria fall into turmoil or when hyper-inflation occurs in countries such as Venezuela, consumers’ purse strings shrink, as do whole distribution channels. So, it’s a risk that these companies face to a much greater extent in emerging parts of the world than in the developed markets. Hottovy: As a side note to that point, a lot of the infrastructure build in emerging markets has been footed by the governments themselves. But a lot of governments are under budgetary pressure. As a result, the responsibility for building infrastructure, whether it is for transportation or water, is falling on the shoulders of the companies themselves. This spending could depress results over the next couple years as companies construct their own infrastructures in emerging markets. Lash: I would also add that food-cost inflation has a much more substantial impact on the emerging-markets consumer than it does in developed markets. For example, 10% to 15% of a family’s income in the United States is spent on food annually. In a country like Egypt, it’s 40% or more. As we see the commodity-cost environment become more favorable, it could have an adverse impact on emerging-markets consumers. K Philip Guziec is an alternatives strategist with Morningstar.

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013

Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot

Morningstar Advisor - April/May 2013