6 Stocks to Watch
These moaty firms all have stable or growing competitive advantages, and are trading near our buying range.
Bargain-hunters may find this market a tough place to shop. As of this writing, the stock market is about fairly valued, according to Morningstar's Market Fair Value chart, which measures the price/fair value of the median stock in our global coverage universe. Yet, volatility has returned to the market in recent weeks. As such, now's a good time to develop a watchlist of quality companies to keep an eye on, if the stock market tumbles and provides a buying opportunity.
This week, we screened our coverage universe for fair value uncertainty ratings of low, and then we separated out those companies with wide or narrow economic moats. (Premium Members can click here to view the screen's complete output.) But we didn't stop there: Because, over time, moats can disappear as competition moves in, we also added a Morningstar Moat Trend Rating criterion to cull the list further.
The six companies you'll find listed below have competitive advantages that Morningstar analysts have deemed to be durable (in other words, they have a moat trend of "stable") or growing (moat trend of "positive"). (Note: The moat trend isn't currently featured on Morningstar.com.)
Right now, none of these companies are screaming buys; they are all fairly valued to slightly undervalued (earning Morningstar Ratings of 3 or 4 stars). But our Portfolio Manager tool makes it easy to set up a watchlist: Just click here, select New Watch List, enter the tickers, save, and you're done. (The share number, purchase price, and commission fields can be left blank.) You can customize your watchlist alerts to tell you about price swings or, if you're a Premium Member, you can be alerted whenever a new fair value estimate or Stock Analyst Report is published.
Moat: Wide | Moat Trend: Positive | Star Rating:
Enbridge operates one of the largest liquids pipeline networks in North America, with more than 2.5 million barrels/day of export capacity from Canada into the United States. In addition, equities strategist Jason Stevens points out that this pipeline operator benefits from the regulated nature of its assets, its ability to lock out competing pipelines from an area or region, and its significant growth opportunities. In particular, Stevens is optimistic about liquid infrastructure projects, including regional and long-haul pipelines that are leveraged to oil sands and Bakken-related projects. "We expect growth in 2015-17 and a 14% compound annual growth rate for EPS by 2018. This should support dividends over the next five to 10 years as more than 75% of earnings are tied to fee-based contracts with terms approaching and exceeding 20 years for new pipelines," Stevens said in a recent analyst report.
British American Tobacco (BTI)
Moat: Wide | Moat Trend: Stable| Star Rating:
Some investors might be opposed to investing in tobacco. But for those who aren't, British American Tobacco has one of the widest moats in Morningstar's consumer-defensive coverage, says senior equity analyst Philip Gorham. British American has a strong presence in Europe, Latin America, the Middle East, and Asia; about 82% of its volume and 58% of its revenue stem from developing countries. At the core of the company's wide economic moat are powerful intangible assets (such as well-known brand names Dunhill, Kent, Lucky Strike, and Rothmans). The company's platform of tobacco products and e-cigarettes gives the firm economies of scope and scale that make it difficult for new entrants to compete. "With few substitute products outside the portfolios of the Big Tobacco firms, a favorable industry structure exists for the largest players in which pricing, for the most part, is rational," Gorham said.
Moat: Wide| Moat Trend: Stable| Star Rating:
One risk that all pharmaceutical companies face is known as the "patent cliff"; essentially, this is the point at which patents expire on established drugs and the company's revenues fall as competition from generic drugs moves in. Though Merck is no exception, senior director Damien Conover says the company is through the worst of its patent cliff, which should remove the heightened generic competition the company has experienced during the last five years. Furthermore, after several years of only moderate R&D productivity, Merck's drug-development strategy is yielding important new drugs. While the new generation of drugs is in development, the patent protections on some of the company's blockbuster drugs (in particular, Januvia for diabetes, Isentress for HIV, and HPV vaccine Gardasil) keep competitors at bay. Overall, Merck's combination of "a wide lineup of high-margin drugs and a pipeline of new drugs should ensure strong returns on invested capital over the long term," according to Conover.
Procter & Gamble (PG)
Moat: Wide | Moat Trend: Stable | Star Rating:
Procter & Gamble's wide moat derives from the economies of scale that result from its portfolio of leading brands, 23 of which generate more than $1 billion in revenue per year (including Always, Pantene, Head & Shoulders, Crest, Tide, and Pampers). According to senior equity analyst Erin Lash, the firm previously entered too many new markets (particularly emerging markets, where competitors already have a leg up) too quickly, and new products failed to resonate with consumers; as a result, its market share position languished. But Procter & Gamble is working to streamline and refocus on more lucrative opportunities. In fact, just this month the company announced that it was shedding 43 beauty brands--about 30% of its beauty-segment sales--to Coty in a deal valued around $15 billion. This sale will allow it to better focus its resources--both personnel and financial--on its highest-return opportunities, enhancing its brand intangible asset and cost advantage, which form the basis of our wide moat rating, said Lash.
Great Plains Energy (GXP)
Moat: Narrow | Moat Trend: Positive | Star Rating:
Great Plains Energy's economic moat owes to its difficult-to-replicate network of power generation, transmission, and distribution assets, with which it provides users with essential electric power. As with all regulated utilities, regulatory caps on revenue and returns preclude Great Plains from establishing a wide economic moat, says equity analyst Charles Fishman. However, investors should reap the benefits of improving regulatory conditions in Missouri, in Fishman's opinion. Great Plains began to increase its dividend in 2011 and 2012, and increases have accelerated in 2013 and 2014. Management is now targeting annual dividend increases of 4% to 6% during the next several years. "The earnings growth combined with the dividend yield should provide investors with mid- to high-single-digit total returns," Fishman said.
Ameren Corp (AEE)
Moat: Narrow | Moat Trend: Positive | Star Rating:
Another regulated utility, Ameren's service-territory monopolies and efficient-scale advantages are the primary sources of its economic moat. Though Ameren serves two of the more challenging regulatory jurisdictions in the country, Missouri and Illinois, equity analyst Andrew Bischof notes that "we see improvement, particularly Illinois," where the Illinois Modernization Action Plan, or IMAP, has improved allowed returns. "As part of the IMAP, the allowed ROE will be set each year based on the 12-month average of 30-year U.S. Treasury yields plus a 580-basis-point risk premium," Bischof notes. Though these allowed returns still trail the industry average, Bischof notes that this automatic-rate-adjustment mechanism is a marked improvement from the whims of Illinois regulators; he believes investors should begin to realize increased dividend payouts as earnings are forecast to grow 8%.
Data as of 7/20/2015.
Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.