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stock picks

Kevin Van Paassen/The Globe and Mail

Cratering commodity prices and a severe selloff in the Canadian banks have left investors with a dearth of attractive opportunities on the home front.

Amid the rocky patch in the S&P/TSX composite index's two largest sectors by weighting, financials and energy, investors have increasingly been turning toward consumer-oriented stocks, especially ones with less sensitivity to the economic cycle.

The S&P/TSX consumer staples index has surged by 30 per cent since the second half of 2014, as the defensive nature of this group coupled with its burgeoning growth opportunities in light of lower oil prices sparked a wave of inflows.

In a note to clients, Credit Suisse analyst David Hartley drew attention to a few catalysts this group has had recently. He cited the continued decline in crude prices and the Bank of Canada's rate cut (which should boost discretionary income by reducing the amount spent on gasoline and mortgage payments), as well as Target Corp.'s decision to exit Canada (which could give other consumer stocks added pricing power and an opportunity to grow market share).

However, these tailwinds might not be as powerful as some presume. For Canadians who lose their jobs in the fallout from oil patch cutbacks, not even rock-bottom gas prices can offset the absence of a paycheque. Other consumers may elect to pocket some of what they save at the pump in light of growing household debt levels, reducing the stimulative effect of lower crude prices.

And as Target is closing up shop in Canada due to its failure to gain sufficient traction with consumers, it is doubtful that its departure will offer a meaningful boost to the remaining retailers. The biggest beneficiary from its departure, from a sales perspective, is likely to be Wal-Mart Stores Inc. – which is a U.S.-listed company.

But as the old adage goes, there are no bad stocks, only bad prices – and after a widespread rally in this segment of the market, there are a number of stocks that have become overextended. Mr. Hartley admits that "consumer indices in Canada are indicating stretched valuations," in particular, the consumer staples index, which is trading at a price-to-earnings ratio above 17 – a level not seen since 2007.

For the majority of the stocks in the analyst's coverage universe, the "rich have gotten richer" since he last published an in-depth analysis of these names in December.

The consumer stocks that look unattractive at current levels include Metro Inc., Alimentation Couche-Tard Inc., Canadian Tire Corp. Ltd. (the lone consumer discretionary stock on this list), Jean Coutu Group Inc., Empire Co. Ltd. and Saputo Inc.

In most instances, the analyst is solely concerned with valuations, as these stocks are trading at significantly higher price-to-cash flow ratios than their historical averages. For Saputo and Couche-Tard, he observes that the market appears to be pricing in the possibility of a large acquisition on the horizon.

At some point, Mr. Hartley warns, there will be a "reversion to the mean trade" that sees these stocks lose their valuation premiums, and suggests that a rebound or stabilization in commodity prices could serve as an impetus for this.

Nevertheless, there are a handful of firms that the analyst does find appealing and rewards with "outperform" ratings: Loblaw Cos. Ltd., George Weston Ltd. and Gildan Activewear Inc.

Investors think Loblaw is a "show-me" stock, according to Mr. Hartley, which should help multiples increase once the company proves it is able meet the Street's earnings estimates. George Weston moves in tandem with Loblaw, as its 46-per-cent stake in the food retailer is the company's principal asset. Clothing maker Gildan, on the other hand, offers superior growth potential at an inexpensive price relative to most of its peers, he said.