The fear of an upcoming recession (and, in particular, stagflation) is on every investor’s mind today. High inflation, the prospect of multiple interest rate hikes, and war in Ukraine has rattled both U.S. and Canadian markets.
Investors with a low-risk tolerance are understandably searching for assets that do well under these conditions to add to their portfolios. For many, this means hard assets like real estate, gold, and commodities.
However, I think differently. I believe that greater allocation to certain stocks is important for a defensive portfolio, especially those from the consumer defensive sector — an often overlooked TSX sector.
These are companies that produce or sell staples that people tend to buy out of necessity regardless of economic conditions, such as food, beverages, household and personal products, packaging, or tobacco. They can often pass on costs to the consumer, which maintains their margins and profitability.
Convenience stores
One of my top picks is Alimentation Couche-Tard (TSXATD.B). The company operates and licenses convenience stores, selling tobacco, groceries, snacks, and alcohol. They also dabble in road and aviation fuels, sell lottery and bus tickets, and even provide ATMs and car wash services.
ATD.B has a massive presence across the world, not just in Canada. ATD.B operates 9,976 company-operated stores in North America, Europe, and Asia, as well as an additional 1,900 franchised stores under the Circle K banner across South America and Oceania.
ATD.B has some excellent fundamentals, with a ROA of 7.86%, ROE of 21.23%. The company had 33.50% quarterly YoY revenue growth. With 21.92% of the share float held by insiders, it’s a strong bet that management thinks the company is currently undervalued. ATD.B pays a small dividend, with a yield of 0.90% but with good growth.
Dollar stores
When pennies need to be pinched (like during a recession), consumers turn to dollar stores like Dollarama (TSX:DOL). With over 1,355 stores across Canada, DOL is a well-known brand to many Canadian consumers. While the stock tends to underperform times of economic growth, it thrives in recessions.
Simply put, when recessions are wreaking havoc on the budgets of Canadian consumers, discount stores like DOL see a resurgence in buyers. When you need to slash your budget, premium grocery stores and retail outlets are no longer viable. The best option here is a dollar store.
DOL is profitable with an operating margin of 20.75% and profit margin of 14.66%. The stock is looking a bit overvalued with a forward P/E of 21.37. Waiting for the stock to fall during the initial stages of a market correction might be a good way to get a better entry price, as its fundamentals would likely be unaffected.
The Foolish takeaway
Investing during a recession doesn’t mean just holding on to gold, cash, and bonds (a bad idea with rising interest rates). Stocks from the consumer defensive sector can add excellent growth prospects to your portfolio, even during a prolonged bear market. These companies are able to maintain their margins during hard times, thanks to the essential nature of their products and services.
