One or the other time, I have published a weekly about consumer stocks. My general view has been for years that these names should be avoided, being it food, beverage, or alcohol stocks, partly also household and cleaning producers (except one name I published a research report about, it’s up +22% over the last five months). Investors who bought blindly solely based on past performance have suffered big losses. While hopes for a turnaround to finally arrive continue to be high, there’s little reason to be overly optimistic. These stocks have lost their status as “defensive” core positions not for one, but for several reasons. The case study of Conagra Brands.
Summary and key takeaways from today’s Weekly
– Consumer staples stocks, especially food producers, still count as defensive picks.
– However, much has changed — the drivers are different and the businesses are not the same.
– Using Conagra Brands as an example, I show why these stocks have shifted from defensive to rather aggressive setups.
I can remember a time when one could not do wrong by buying so called defensive consumer stocks. Due to the recurring and thus practically safe demand for their products like food, beverages or hygiene and cleaning stuff, these businesses were not only not cyclical, but even more important, offered stability during market stress.
Not spectacular, but boring and steady was the recipe for success.
Winning by not losing.
Among the most famous examples is Warren Buffett’s core holding Coca-Cola (ISIN: US1912161007, ticker: KO) — which by the way is one of few examples, where the stock is still doing comparatively well, without much to criticize from my side, except that the stock is too expensive for me.
This “quality” perception was built on recognizable brands, pricing power, long track records, safe and recurring demand, modest growth, rising margins, and of course safe and rising dividends. Unfortunately, what followed indeed was very spectacular: shocking losses for investors who did not notice fundamentals have been changing.
On top of maxed out valuations.
Accordingly, many investors wonder whether and especially when the bear market will be over as defensive names cannot fall forever. In this weekly, I am not going to write again about what I consider to be still too-high valuations.
Instead, I hope I can convince you — using food producer Conagra Brands (ISIN: US2058871029, ticker: CAG) as a case study — that these stocks are much less defensive than is widely believed.
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The Difference between defensive and aggressive
Little surprising for long-time Financial-Engineering readers, many consumer names have fallen sharply over the last years.
In an older weekly (see here), I had warned close to the top about this sector to be maxed out valuations-wise, and ready for a big disappointment. You can ignore the not so well chosen title of this analysis, but the core message was correct for the most part.
What happened since is that the cost of living crisis has expanded.
And it turned out that most people suddenly stopped caring about brands when it comes to everyday essentials. This “erosion of brand values” (see here) has been challenging companies that were thought to be practically invincible and among the most defensive tickers one can buy on the stock exchange.
Many investors got caught off-guard.
Not only have these companies seen unprecedented declines of their stocks, but their businesses are not the same anymore.
While I often read in company publications about constantly repeating excuses just a cyclical correction that is fixable, it does not really seem to be a short-lived, easily solvable issue.
The problems are more deeply rooted.
One big thing many investors still seem to be underestimating is the demographic collapse (see here). The consequence is that with every next generation, the potential consumer pool almost halves in many Western nations. Even if one were to consume more or be more wasteful than the ancestors, there’s a natural limit before overall volumes for everyday essentials first stop growing, then start falling.
We have reached this point, it seems.
Every generation means in about 20-30 years time. So, what worked in the year 2000, cannot be assumed to still be working as if nothing changed. Adding the still-sticky inflationary pressure — many consumer staple products see more than the typical 2–3% annual price adjustment — it becomes clear why these companies turned from reliable growers into troubled wrecks.
People switching to cheaper private-label offerings is one thing that is well known by now.
But where I am having a big issue with is calling these companies “defensive”. This does not fit anymore to the businesses as such, as most of them must decide between sales, volumes, and margins. All together up in one direction does not work anymore.
On top come the very fragile balance sheets — an aspect I fear too many people are still ignoring. And it is not just about elevated leverage levels, which offers enough room for criticism. The asset values in the books in many cases are likely overstated relicts of the past.
What triggered me to write this weekly was the company Conagra Brands, a big food producer (frozen food, snacks, etc.) and dividend darling.
In their latest earnings release, published shortly before the Christmas holidays, CAG had to conduct another major asset write down.
Almost a full billion USD evaporated from the balance sheet.
This is something I have been pointing towards for longer now — don’t take the assets at face value. This is what I mean by aggressive versus defensive, as you will see now.
What is on the balance sheets often has historical values, to a large part stemming from costly acquisitions (goodwill), where in this case Conagra Brands paid a premium for the bought assets. This worked under the assumption growth will continue and the assets will justify this growth premium in the future through higher cash flows.
As growth isn’t there anymore, the premiums often are anything, but justified.
If you see assets mainly consisting of intangibles, better be cautious.
Despite still persistent inflation (that in the past made it easy to bump up prices for such companies), Conagra is not even able to grow sales in absolute terms.
The latest figure showed one of the lowest sales levels over the last five years (trailing twelve months each).
Adding margin pressure and falling results, makes it hard to believe a bottom might be near.
Despite not being well known here in Germany, Conagra is absolutely not a nobody.
Not too long ago, this company had a market cap of 20 billion USD. In relatively short time, this figure more than halved, which on its own is already quite dramatic.
Every time you read or hear about “just a cyclical correction”, keep this in mind.
Looking now at what’s left of some of their assets, we can see 8 billion USD in equity.
This might create the impression that CAG stock is a bargain, trading close to its book value, being worth a shot with its defensive business model.
However, goodwill alone — the recent impairment already included — is higher than equity. Adding the remaining 2 billion USD in other intangibles, and we have fat negative tangible book value.
In that sense, you can forget to value this one via book value, as equity (i.e. book value) can quickly be eradicated, as seen above in the latest quarterly results.
This would be less of an issue, if the old growth story were intact.
But it is not. Accordingly, the balance sheet in my view is highly inflated with hot air — asset values that don’t stand the test of time.
On the other side, debt has truly ballooned. Despite being on the way down, Conagra still carries around a hefty debt load of 7.6 billion USD. You almost need a magnifier to find the cash position on the same chart (green bars).
For the sake of completeness, let’s have a quick look at free cash flow.
9x current FCF in net debt is not little. And this debt will not evaporate in the same way equity can and frequently does. The setup is the opposite of defensive — we have high risks spread over the balance sheet, and not the widely perceived defensive spirit, only because the company is selling food.
It is a very similar pattern across many of such pretend defensive companies / stocks.
I have chosen Conagra Brands here just as an example. The issues are widespread and almost the same. Over-expansion and a changing business environment led to inflated assets on the balance sheets, while real and pressing debt loads work against crumbling-apart businesses that need to adjust and right-size.
These companies likely are not going to go bankrupt — at least at the moment it does not look this way. My core message is a different one: with a very weak asset side and businesses that turned from solid, predictable growth into challenged and pressured entities, today’s setups are entirely different than in the past.
Thus, the evergreen tips to buy and hold “defensive” stocks should be viewed skeptically today and through a different lens.
And no stocks should be bought blindly only because it has worked sometime in the (distant) past or someone told you so in a click-baity video or social media post, without understanding the mechanics and drivers behind a stock, i.e. a real company and its operating environment.
I want to finish with a positive note: there will likely be a time to gobble up such pieces. The same for alcohol stocks, which I am closely watching. But this time is not now — I am frequently writing about my observations and the prevailing issues. The risks remain too high, the valuations still not attractive.
It could be wise to better prepare for dividend cuts. Conagra is likely close to this painful step.
But this could be the sign to get active. My members will be the first to know.
Conclusion
Consumer staples stocks, especially food producers, still count as defensive picks.
However, much has changed — the drivers are different and the businesses are not the same.
Using Conagra Brands as an example, I show why these stocks have shifted from defensive to rather aggressive setups.
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