Tags: Consumer | Cyclical | Stocks | Undervalued

Morningstar: Consumer-Cyclical Stocks Are Undervalued

By    |   Friday, 29 June 2012 11:49 AM

Consumer-cyclical stocks experienced a better-than-expected first half of 2012 and there are more reasons for optimism in the second half of the year, Morningstar reported.

While the firm’s underlying thesis for the year of relatively slow and sometimes volatile economic recovery in the United States “remains intact,” consumer-cyclical companies typically reported stronger-than-expected sales, margin and earnings-per-share gains in the first half.

Morningstar maintains its “cautious optimism” for the second part of the year, as slow real-wage growth, a sluggish housing market and the political environment have created a “choppy economic recovery.”

Although the firm forecasts a mild decline in sales for the second half, it projects steady, possibly expanding, margins.

The expected mid-single-digit comparable-store sales growth for the year would be “more than enough to generate some selling, general and administrative expense leverage for most firms in 2012,” Morningstar said, as consumer-cyclical companies continue to operate under lean cost structures.

In the long term, margins might begin to show signs of structural declines in certain retail situations. For instance, Morningstar believes the retail sector is “simply overstored” and Amazon.com Inc. makes the saturation problem worse.

Consumers will continue to be focused on value in the future, which would stall any price increases for most retailers.

Responding to competitive pressures, most consumer-cyclical companies have reinvested in channel-diversification strategies and supply chain and infrastructure investments, as well as renovated consumer-facing assets.

Online and mobile-device sales continue to increase and will be a source of revitalization for mature retailers, according to Morningstar. However, brick-and-mortar chain stores “have a lot of catching up to do” in the online arena to try to compete with Amazon, which had $48 billion in revenue in 2011.

Because of the high returns and interest from customers to shop online, Morningstar expects ongoing investments in e-commerce for nearly every retailer.

Most consumer-cyclical firms have accumulated sizable cash stockpiles during the previous few years due to aggressive cost-cutting strategies and conservative capital budgets. The firm expects cash and equivalents will account for approximately 20 percent of total assets for consumer-cyclical companies at the end of the year.

Although having cash stockpiles “isn’t a bad thing in this environment,” Morningstar noted, “we doubt the market is willing to reward companies for sitting on this cash.”

Therefore, a growing number of consumer-cyclical firms have announced dividend increases and/or increased their share-repurchase programs.

The investment research firm is forecasting low-double-digit growth in earnings per share for consumer-cyclical companies in 2012, noting that this “might seem somewhat aggressive in the context of our industry expectations for mid-single-digit comparable-store sales growth, low-single-digit unit expansion and muted operating margin expansion.”

Overall, Morningstar believes the consumer-cyclical sector is 5 percent undervalued.

The firm’s top consumer-cyclical stock picks are Las Vegas Sands Corp., eBay Inc., Time Warner Inc., Kohl’s Corp. and Guess? Inc.

“There are few outright bargains, though we continue to focus on later-cycle categories such as home improvement, which may strengthen as the recession cycles,” Morningstar wrote.

Retail sales in May fell 0.2 percent after decreasing the same amount in April. However, retail sales excluding automobiles, gasoline and building materials rose 0.1 percent in May.

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