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Stocks  | January 31, 2019

Who knows what 2019 will bring? It’s very possible the market will take another wild turn. And if so it’s best to be prepared. Consumer stocks are a terrific way to diversify your portfolio.

But not all the consumer staple stocks are worthy investing opportunities. What does this mean? You have to know the ones to watch.

Luckily Wells Fargo is here to help. The firm’s Bonnie Herzog is a top-rated analyst according to TipRanks. I mention this because she has just released a report setting out her top consumer stock picks for 2019.

First thing to note is that Herzog is more cautious on the staples sector for 2019 than this time last year. That’s because of multiple factors from global macro-uncertainty, to stretched valuations and margin pressures (although these are now easing).

Nonetheless she still sees ‘pockets of opportunity’, particularly in the beaten down Tobacco sector. Indeed, her sub-sector rankings remain #1 Tobacco and #2 Beverages. As you will see these sub-sector preferences come across in her five picks for consumer stocks. Let’s take a closer look now:

Philip Morris (PM)

So this one may come as a surprise. The #1 consumer staples stock for Herzog for 2019 is Philip Morris International (NYSE:PM). Yes, the owner of Marlboro. Yes, the stock where the analyst consensus remains a pretty underwhelming Hold.

But if you take a glance at the analyst’s reasoning, this bullish view begins to make more sense.

First, Herzog explains why the tobacco industry deserves a closer look: “We reiterate our bullish outlook on the Tobacco sector given very attractive valuations, pricing power, strong & recurring cash flow streams, attractive dividend yields and upside from reduced-risk products.”

And within the tobacco sector, PM is her top stock pick. Partly that’s thanks to iQOS, PM’s new heat-not-burn cigarette alternative. “We believe it’s reached an inflection point and the set-up for 2019 is positive given: easy comps, right sized iQOS inventories in Japan, new iQOS innovation and strong cig fundamentals/pricing” writes Herzog.

From current levels, she sees shares surging 37% to hit $100.

Plus its hard to ignore the very generous dividend payments. Philip Morris is a veritable dividend darling. The company currently pays a lucrative quarterly dividend of $1.14. That makes for an extremely high dividend yield of 6.27%.

Constellation Brands (STZ)

Our number two stock: drinks legend Constellation Brands, Inc. (NYSE:STZ). You probably know STZ from its Corona beers and recent expansion into the buzzing cannabis space via Canopy Growth Corp (NYSE:CGC).

“STZ remains our top Beverage pick, as we think the sharp selloff following weaker than expected FQ3 results is way overdone” says Herzog. Shares are down 18% over the last three months. Essentially investors can now buy STZ’s beer business for a market multiple and get a free call option on cannabis.

As a result, the risk-reward is looking very favorable into 2019 (i.e. STZ’s FY20). Three potential catalysts for shares are as follows:

  1. Too low expectations. STZ is currently trading at an historic low of 10.9x, which is almost four turns below its 3-year hist avg.
  2. Likely continued strong premium beer segment growth led by Modelo and Corona
  3. Potential upside to beer margins

And in the background is STZ’s massive $4 billion cannabis stake. “We remain excited about STZ’s opportunity in the cannabis space with its current ~35% stake in Canopy Growth” writes the Wells Fargo analyst.

Crucially, given little evidence of beer cannabilization in any of the U.S. markets where cannabis is currently sold, future sales in the U.S. could be ‘close to 100%’ incremental for STZ.

This supports the analyst’s bullish outlook on the US opportunity, currently estimated to be $50B going to ~$96B by 2032. Plus with Congress’ recent passage of the U.S. Farm Bill, hemp-derived CBD is one step closer to being removed from the Controlled Substances Act.

With a Moderate Buy analyst consensus, STZ’s average price target works out at $206.5 (24% upside potential). 

Altria Group (MO)

Ok so alongside Philip Morris, you can also invest in its parent company, Altria Group (NYSE:MO). For Herzog, this stock takes third place in her top picks for 2019. She is “frankly mystified” by the sharp drop in Altria’s share price (8% year-to-date).

“We believe Marlboro stabilization trends should continue… supported by a strengthened loyalty program, more effective promos & a normalization of distributor inventory levels” she writes.

Now MO also boasts a sizable shareholding in popular e-cigarette maker Juul. Back in December, Altria invested a jaw-dropping $12.8 billion for a 35% stake in the company.

What sets Juul apart is its patented nicotine salts. Unlike other e-cigarette products, these salts deliver nicotine to users almost exactly like a cigarette. The company’s own patent reveals that:

“[N]icotine salt formulations provide satisfaction in an individual superior to that of free base nicotine and more comparable to the satisfaction in an individual smoking a traditional cigarette.”

Citing this investment in Juul as a savvy hedge against potentially declining cigarette sales, Herzog explains: “Should cig vol declines accelerate as a result of JUUL, MO’s 35% equity stake should provide some level of offset.”

At the same time, the pressure on MO’s stock price as the market digests the rationale of the Juul investment creates an attractive entry point for long-term investors.

Herzog’s own $65 price target suggests upside potential of 47%. From the Street, MO gains a Moderate Buy consensus rating with a $58 average analyst price target. 

Coca Cola (KO)

Turning back to the world of beverages we have fizzy-drink king Coca-Cola Co (NYSE:KO). A “Sleepy Outperformer” with an increasingly exciting focus on M&A — is how Herzog describes the stock.

That’s backed by the company’s recent Costa Limited acquisition for $4.9 billion. The goal: to expand from soft drinks into a true Total Beverage Company.

Indeed, CEO James Quincey’s strategic vision for KO is to double its total addressable market size (from $0.8 trillion to $1.5 trillion). So snapping up global coffee chain Costa is a great move in this direction.

“We still view KO’s Costa Limited acquisition for $4.9B (which closed on 1/3/18) very favorably and continue to see it as a big opportunity for KO over the long term — especially given its potential as an accelerator of KO’s strategy to be the global beverage and coffee leader” the analyst writes.

For KO, Herzog spies a positive risk-reward into 2019. Compared to peers, KO has a relative advantage in a rising labor cost environment. That’s given its refranchising & incidence based pricing (both underappreciated positives into 2019).

“We remain confident that 2019 will be an opportunity for management to further demonstrate KO’s relative strength across its domestic and international footprint” she concludes.

Currently the stock’s consensus comes out at Moderate Buy. On average, analysts see KO delivering a 12% upside from the share price right now of $47. 

Coca-Cola European Partners (CCEP)

If you already like Coca-Cola, why not also take a closer look at Cola-Cola European Partners PLC (NYSE:CCEP)?

This beverages-related stock also has a prominent place on Herzog’s buy list. That’s with a $52 price target for 16% upside potential.

CCEP is a multinational bottling company dedicated to the marketing, production and distribution of Coca-Cola products.

For CCEP, we see a positive risk-reward into 2019 — and we expect CCEP to benefit from continued strong macros and solid execution, says Herzog.

This should support a solid price/mix in Beverages in the near-term and accelerating volume growth over the long-term. “What’s more, we believe that shares are likely to increasingly reflect more investor confidence in CCEP’s long-term growth potential and alignment with KO.”

Indeed the stock faces an ‘exciting’ 2019 thanks to a slow of savvy initiatives including increasing digital capability as well as a faster growing total addressable market (2-3% CAGR thru 2028, up from 1.1% between 2010 and 2017).

Overall the consensus for CCEP stands at ‘Moderate Buy.’ That’s with a $52 average analyst- exactly in line with Herzog’s own price target.

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