On-again, off-again U.S.-China trade tensions. An inverted yield curve. Worries about global economic growth. These factors have injected a good deal of uncertainty into the market during the past two weeks. Whether or not stocks continue their upward march is anyone’s guess. But playing a little bit of defense with your stock portfolio may not be the worst idea.
Last week, we shared some inexpensive, defensive stock ideas. Specifically, we homed in on stocks in Morningstar’s Defensive Super Sector, which includes the healthcare, consumer defensive, and utilities sectors--pockets of the market that are generally immune to economic cycles. We then narrowed the field further by screening for names with Morningstar Economic Moat Ratings of wide or narrow within that Super Sector, ensuring that we were cherry-picking only the financially healthiest and most profitable companies. We tossed out stocks with high or greater Morningstar Uncertainty Ratings, thereby eliminating companies with less predictable cash flows. And lastly, we demanded that these defensive names be trading at Morningstar Ratings of 5 stars--significantly below our fair value estimates. Just nine stocks made the cut.
This week, we’re continuing with the defensive theme but loosening our valuation standards a bit. We’re using the same screening criteria as last week, except we’re dipping down the valuation scale to stocks carrying 4-star ratings. These stocks don’t possess the same margin of safety as their 5-star counterparts, but they’re still trading below our fair value estimates, adjusted for uncertainty.
This time, 22 stocks made the list. Here’s a sector-by-sector look at these defensive names, as well as a deeper dive into one stock within each group.
Healthcare
It’s no surprise that the healthcare sector is generally recession-resistant and considered defensive. After all, we continue to fill our prescriptions and visit doctors no matter what. Most of us value our health above almost anything else.
An analyst favorite in this sector is Zimmer Biomet (ZBH). The medical-device maker--a leader in hip and knee implants--earns a wide moat rating, stemming from two sources. There are substantial switching costs for orthopedic surgeons, observed senior analyst Debbie Wang. Moreover, Zimmer’s intellectual property protects the product portfolio, serving as an intangible asset.
“We expect favorable demographics, which include aging baby boomers and rising obesity, to fuel solid demand for large-joint replacement that should offset price declines,” says Wang.
We hiked our fair value estimate by nearly 16% last month, to $160 per share. Shares are trading 14% below our fair value estimate as of this writing.
Consumer Defensive
The consumer defensive sector brims with familiar brands. These companies produce our comfort foods, brew our beers, and provide us with a place to buy those foods and that beer. We’re unlikely to abandon the products that these companies make or the distributors that sell them, no matter the economic climate.
One of our analysts’ favorite stocks on the list is Kroger (KR).
“With durable vendor relationships, established store banners, industry-leading transaction data and analytics capabilities, a top-tier private label lineup, and a favorable cost position, we believe narrow-moat Kroger is better positioned than most pure-play peers to weather the change that has roiled the industry,” argues analyst Zain Akbari.
He notes that Kroger can use its advantages to drive the efficiencies necessary to keep pace against its rivals. Moreover, partnerships with Microsoft (MSFT), Walgreens (WBA), and Ocado (OCDGF) should allow it to accelerate its transformation, thereby allowing it to successfully capitalize on the changing landscape.
“Kroger’s prospects are better than those implied by prevailing trading prices, leaving an attractive opportunity for long-term investors willing to wait for the firm’s turnaround efforts to bear fruit,” he concludes. Shares are trading about 18% below fair value as of this writing.
Utilities
Our last defensive sector is utilities. We continue to need electricity, gas, and water whether the economy is expanding or contracting. Moreover, utilities’ consistent dividends can be a source of comfort during periods of stock market uncertainty.
The only undervalued utilities stock in our coverage universe is Dominion Energy (D)--and it’s a familiar name to regular readers of Morningstar.com. We talk about it a lot because it’s a standout in many ways. For starters, it’s the only utility that earns a wide economic moat rating. It carries low uncertainty and a stable moat trend. It’s also managed by exemplary stewards of capital. And we think it has great growth prospects--and an attractive 4.77% dividend yield, to boot.
The company’s smart strategic pivot supports its wide economic moat.
“Since 2010, it has focused on the development of new wide-moat projects with conservative strategies, exited the exploration and production business, sold or retired no-moat merchant energy plants, and made significant investments in moaty utility infrastructure,” explains analyst Charles Fishman.
This low-uncertainty name is trading at an 8% discount to our fair value estimate as of this writing.
