La diferencia entre “defensive” y “quality” usando SJM como ejemplo
I’m probably going to ruffle some feathers with this, but will go ahead and say it anyways…
People often misunderstand the difference between Defense and Quality, and attribute a Moat to companies that in my opinion have little or none.
The difference between a Defensive stock and a Sensitive stock has to do with how the earnings respond to macroeconomic conditions. Consider UTX, for example? Earnings fell from $4.90 to $4.12 between 2008 and 2009. Cash flow fell from $6.38 to $5.43. (All numbers from ValueLine.) Or CSCO? Earnings fell from $1.31 to $1.05 while cash flow fell from $1.66 to $1.37. These are strong companies that were never endangered by that drop in earnings, and they recovered quickly, but there is no denying that they are economically sensitive! In a recession you might expect a 20% decline in earnings in addition to a 20% to 40% decline in P/E multiples.
In contrast, PG is your classic defensive giant. Its earnings fell from $3.64 to $3.58, cash flow from $4.97 to $4.86. We did see P/E multiples contract, along with the rest of the market, but the denominator – earnings – was remarkably steady. Even while the global economy was going to hell in a handbasket, PG was selling product and turning a steady profit.
Once again, all three of these companies are what I would consider High Quality companies. They have strong credit ratings, diversified revenue streams, and the financial strength to make it through an economic downturn without damage to the business. All three companies survived and ultimately did very well. Heck, the Defensive company has been the WEAKEST of the three over the last fifteen years. (Not that anybody is complaining.)
In contrast, we have companies like SJM. SJM is clearly a Defensive company. Their sales ought to be relatively insensitive to macroeconomic conditions. People are not going to stop buying peanut butter and pet food in a recession. Their margins are impacted to a certain extent by currency translation and commodity costs, but have little to do with GDP growth.
Yet the quality of SJM does not compare to the quality of UTX, CSCO, or PG. The Big Heart acquisition stretched their finances, knocking them down from A3 credit (solid) to Baa2 credit (weak). Over the past 4.5 years they have struggled under this burden through a pattern of underinvestment (hurts revenue growth), divestments (hurts revenue growth), and debt reduction (hurts revenue growth). And their debt is STILL more than three times EBITDA.
At this time, SJM is hoping to stabilize revenue. Not grow. Not expand. Survive. They are definitely cheap on a P/E basis, and seem to have ample FCF to cover the dividend, but persistently shrinking revenues are a bad sign for any business, let alone one carrying a heavy debt load.
So you might do well buying and owning SJM. You get a bargain price on the business, and if they can eventually figure things out then the shares will eventually rebound. Moreover, it is very clearly a Defensive company. You don’t need to fear an impending recession, because that is unlikely to be material to their situation. But it is a no-moat company (even Morningstar agrees at this point) with borderline quality metrics. Management needs to execute or things could get really bad in a surprisingly short time. SJM is in better shape than KHC was, but not THAT much better shape.
So don’t confuse Defensive with Quality. A Defensive company need not fear a recession, but may still be at risk from mismanagement (and the incestuous management at SJM is a poor recipe for success). A Quality company has the strength to work through almost anything.