Consumer Discretionary: Eleven A-Grades Built on Tourism

Consumer discretionary just posted eleven A-grades out of 25 companies analyzed. That's a 44% A-grade rate, which sounds impressive until you notice something strange: the sector's success stories aren't coming from traditional retail or automotive. They're coming from travel, entertainment platforms, and restaurants. The companies actually selling physical products to consumers? They're struggling.

The Travel and Platform Dominance

Airbnb leads the sector with a 40.7% FCF margin and an improving trend. Booking Holdings sits at 33.3%, though its trend is declining. Netflix clocks in at 20.9% with an improving trajectory. Electronic Arts posts 24.9%. Spotify, despite years of profitability questions, now runs a 14.6% margin on an improving trend.

These aren't discretionary companies in the traditional sense. They're platform businesses that happen to serve consumer discretionary spending. Low inventory. High variable costs that can flex with demand. Digital distribution that doesn't require physical footprint expansion. McDonald's at 25.7% fits this pattern too: real estate income and franchise fees generate cash without the capital intensity of owned locations.

The sector's median FCF margin of 10.2% is respectable, but strip out the platform businesses and that number drops fast.

The Traditional Retail Problem

Nike sits at 7.1% with a declining trend and a D grade. Lululemon runs 15.0% but trends declining despite the A grade. TJX manages 7.4% with a B grade. Home Depot posts 10.2%, stable but not growing. Lowe's comes in at 9.2% with a declining trend and a D grade.

These are big, established retail names. They should be efficient cash generators by now. Instead, they're either treading water or sliding backward. The issue isn't revenue. Most of these companies are still posting sales growth. The issue is that every dollar of revenue requires more working capital, more inventory management, more physical infrastructure. That eats into free cash flow.

Starbucks tells the story clearly: 6.6% FCF margin, stable trend, F grade. The company grew aggressively, added locations, and now carries the fixed costs of thousands of stores. The cash generation doesn't justify the footprint.

The Automotive Disaster

Tesla: 6.6% FCF margin, declining trend, F grade. Ford: 3.6%, improving from an even worse position, still an F. GM: 1.0%, improving, F grade. Amazon, which isn't automotive but operates like one in terms of capital intensity, posts 1.1% with a declining trend.

The sector average debt-to-FCF ratio of 9.0x is being dragged up by these companies. When you're generating minimal free cash flow and carrying massive debt loads to fund production capacity, the math doesn't work. Tesla's declining trend is particularly notable given the EV narrative. The company's margin has compressed as competition arrived and price cuts became necessary.

Ford and GM show improving trends, which sounds positive until you realize they're improving from margins below 4%. That's not a recovery story. That's stabilization at a level that barely qualifies as free-cash-flow-positive.

The Cruise Line Paradox

Royal Caribbean: 12.1% FCF margin, declining trend, F grade. Carnival: 9.8%, declining, F. Norwegian: 8.8%, declining, F.

These margins aren't terrible by consumer discretionary standards. Royal Caribbean's 12.1% would earn an A grade in this sector based purely on margin. So why the F grades? Balance sheets. These companies loaded up on debt during COVID shutdowns and haven't deleveraged fast enough. The Aureus grading system penalizes high debt-to-FCF ratios because debt service consumes cash that could otherwise compound. When your debt-to-FCF ratio pushes into double digits, you're running on a treadmill.

The declining trends compound the problem. If margins were expanding while debt paid down, you'd see a path to upgrade. Instead, these companies are generating solid cash flow in a good environment while their grades reflect the structural risk underneath.

What the Trend Split Means

Eleven companies show improving trends. Eleven show declining trends. Three are stable. That's a sector at an inflection point, not a sector with clear momentum.

The improving names skew toward platforms and entertainment: Airbnb, Netflix, EA, Spotify, Roblox. The declining names skew toward physical retail, automotive, and cruise lines: Booking, Lululemon, Chipotle, Disney, Lowe's, Nike, Tesla, Amazon.

That split suggests two different consumer discretionary sectors operating under the same label. One is capital-light, digitally native, and generating improving cash flow. The other is capital-intensive, inventory-dependent, and struggling to maintain margins as costs rise.

Disney's Warning Sign

Disney posts a 10.7% margin with a declining trend and a D grade. This is notable because Disney spans both worlds: streaming platform (capital-light) and theme parks plus content production (capital-intensive). The blended result is a company that looks okay on the surface but can't seem to convert its revenue scale into strong free cash flow.

If Disney, with its brand power and diversified revenue streams, can only manage 10.7% on a declining trend, what does that say about the structural challenges facing traditional discretionary businesses?

The Sector's Real Health

Consumer discretionary looks healthy if you focus on the A-grade count. It looks bifurcated if you examine what's earning those grades. The sector's strongest performers are platform businesses that don't face the capital intensity of traditional retail or manufacturing. The weakest performers are exactly the companies most people think of when they hear "consumer discretionary": automakers, retailers, cruise lines.

The sector's 9.0x average debt-to-FCF ratio is high but not catastrophic. The problem is distribution. A few heavily leveraged companies drag the average up while the platform businesses run with minimal debt. That creates a misleading composite picture.

If you're constructing a consumer discretionary portfolio based on Aureus grades, you're effectively building a platform and entertainment portfolio with McDonald's thrown in. The traditional discretionary names aren't making the cut. That's not a flaw in the grading system. That's the grading system telling you where the cash flow actually lives in 2026.