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Market Update

6 Foreign Stocks Top Managers Have Been Buying

Managers from Artisan, Dodge & Cox, and Fidelity picked up a consumer staples company, banks, and a Canadian railroad, among others last quarter.

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Every quarter, investors eagerly await Berkshire Hathaway's (BRK.A) (BRK.B) 13-F filing. The document reveals which stocks Warren Buffett and Charlie Munger bought and sold the prior quarter, thereby providing investors with a potential shortlist of stocks to investigate further. Just recently, we discovered that they picked up shares of Apple (AAPL), Delta Air Lines (DAL), and Goldman Sachs (GS), among others, last quarter.

Getting stock ideas from great investors is a favorite pastime of ours at Morningstar.com. Last week, we took a look at several stocks some of our favorite large-cap domestic-equity focused managers bought last quarter. This week, we're peeking into the portfolios of some of our favorite foreign-stock fund managers to find out what they've been buying. After all, good stock ideas know no borders.

At Gold-rated (and closed) Artisan International Value (APHKX), David Samra and Dan O'Keefe maintain a compact portfolio of quality companies with financial strength and shareholder friendly management. They buy those companies when they're trading well below the duo's assessment of intrinsic value. Last quarter, they took new positions in Nestle (NSRGY) and Bayer (BAYRY) and added to their stake in Sodexo (SDXOF).

Nestle is no stranger to the portfolio; Samra and O’Keefe have owned the giant food company before. They explain in their latest commentary:

"There are three problems with Nestle that create a gap between the current price and fair value for shareholders. First, the company's revenue performance has been deteriorating for several quarters. Part of this is portfolio-related. Nestle still has a decent number of slow growth businesses that are dragging down the company's overall growth rate. Second, Nestle's margins are below benchmark levels. Third, the company has excess capital that should be redeployed. We are referring primarily to Nestle's stake in L'Oreal, which is currently worth €27bn or about 13% of Nestle's market cap. This is a purely financial holding that should be disposed of and the proceeds used to repurchase shares."

The duo thinks these issues are addressable, and that new CEO Mark Schneider will lift margins. They also note that Third Point, an activist fund, has taken a stake in the company in an attempt to accelerate the pace of change.

Morningstar assigns Nestle a wide moat, a stable moat trend, and a low uncertainty rating. Shares are fairly valued by our metrics.

"Nestle has undershot its benchmark 'Nestle model' organic growth rate of 5%-6% for four consecutive years, and we think it will be difficult for the firm to recapture such growth levels in the medium term," argues sector director Philip Gorham in his latest report. "Both cyclical and structural factors play a part in Nestle's deteriorating growth profile, but ultimately, we think the behemoth consumer staples company is poised for slower organic growth over the next decade than it achieved in the last."

However, Nestle is defending its shelf space, adds Gorham, and Schneider's two-pronged strategy to lower the cost structure of the business and transition the portfolio to higher-growth businesses is appropriate.

Artisan's second new position is in German behemoth Bayer. They explain:

"Bayer operates in several segments, including crop science, pharmaceuticals, animal health and OTC pharmaceuticals. The size and market position of the crop science business was recently increased through the $63 billion acquisition of Monsanto. The marriage of Monsanto's leading position in seed technologies with Bayer’s leading position in herbicides and pesticides should create the world's most competitive crop science business. Unfortunately, the requirement to borrow most of the $63 billion purchase price along with fundamental issues within the company's OTC pharmaceutical segment has dampened sentiment around Bayer's share price."

Morningstar assigns Bayer a narrow moat and stable moat trend; shares are significantly undervalued according to our metrics. The stock plunged this week after a California jury ordered subsidiary Monsanto to pay $289 in damages due to allegations that its glyphosate-based weed killers caused cancer. Morningstar doesn't expect to make material changes to Bayer's fair value estimate or moat rating as a result of the litigation, says sector director Damien Conover in his lastest note, and our long-term thesis is intact.

"Largely on the basis of the strong competitive advantages of the healthcare group and to a lesser extent the crop science business, we believe Bayer has created a narrow economic moat," he explains. "In the healthcare division, Bayer's strong lineup of recently launched drugs and solid exposure to biologics should support steady long-term growth." And the Monsanto acquisition will significantly expand the competitive position of Bayer's crop science segment.

Lastly, Samra and O'Keefe added to their existing position in Sodexo, the world's second-largest catering company. They've owned Sodexo for more than a decade, but had trimmed back their stake due to high valuation and a change in the company's strategy and culture. But new leadership has taken control, which they view as good news.

"Outsourced catering and facilities services is a secular-growth industry, characterized by high returns on capital and strong free cash flow," they suggest. "During Q2, new management reduced the profit outlook for the business, laid out a significant repudiation of the prior management's strategy and announced a strategic review. The aim of the new strategy is to re-orient the business back toward core catering contracts, which should improve growth and margins over time."

Morningstar analysts don't cover the ADRs of Sodexo, but according to our quantitative models, they're trading in 4-star range. We do, however, cover the European shares  (SW). The company earns a narrow moat and stable moat trend.

"As one of only two global food service providers in a highly fragmented market, Sodexo is well positioned to benefit from the outsourcing trend that has pervaded developed markets in recent years," comments analyst Michael Field in his latest analysis. "Sodexo has also been successful in taking market share from smaller, more local providers that cannot match the operational capabilities and proprietary knowledge that come from operating on a global basis."

The team at the Gold-rated (and closed) Dodge & Cox International Stock (DODFX) hunts down stocks that look cheap from a variety of different valuation measures, favoring companies with strong management, competitive advantages and solid growth potential. They added to their already-substantial position in bank stocks last quarter.

"Financials, which have been one of the weakest areas of the market, exemplify the recent trend of lower valuations despite improving fundamentals," they assert in their latest commentary. Management teams are cutting costs, strengthening balance sheets, and improving returns on equity, they say. They added to their position in Itau Unibanco (ITUB), which they call "one of the best-managed banks in the world," during the second quarter.

"Itau Unibanco declined 32% in U.S.-dollar terms in the second quarter (or 21% in local currency) as a weakening Brazilian currency and higher fuel prices raised concerns about inflation and weaker economic growth in Brazil," they report. "While we recognize these risks, we are comforted by the fact that the management team has successfully navigated significant economic volatility in the past and generated an average return on equity of 26% over the last 20 years. Recent data show loan growth is recovering after a severe recession from 2015-16, and the long-term outlook for higher credit penetration remains promising. .. Itau has weathered credit cycles better than its state-owned competitors, enabling it to earn superior returns."

Itau doesn't earn an economic moat from Morningstar, and it carries a very high uncertainty rating. Shares are highly overvalued today according to our metrics.

"Despite Brazil’s shaky economy, Itau continues to perform," admits analyst Colin Plunkett in his latest report. "Nevertheless, we are still cautious on the Brazilian economy and at some point, we believe the country's struggles will begin to affect the bank’s performance and are surprised the bank has performed so well despite the trucker strikes and slowing economy."

The Dodge & Cox crew also added to UniCredit (UNCRY) last quarter:

"Recent fears that a new anti-establishment Italian government would leave the Eurozone or repudiate debt have overshadowed the progress UniCredit has made in improving its balance sheet and profitability. From 2014 to 2017, UniCredit's non-performing loan ratio declined from 16.5% to 10.3%, and its adjusted return on tangible equity increased from 4.6% to 7.6% on a much bigger capital cushion. In spite of these improvements, the company's valuation declined from 0.7 times price to tangible book value to 0.6 times. Current valuation does not give credit for UniCredit's deep restructuring of its balance sheet and cost structure, and reflects market skepticism of management reaching its target of 9% return on tangible equity. However, we believe their target is achievable through internal self-help measures, and we added to the Fund’s UniCredit position during the second quarter."

Morningstar analysts don't cover the ADRs of UniCredit, but according to our quantitative models, they're trading in 4-star range. We do, however, cover the European shares  (UCG). The bank doesn't earn an economic moat and carries a very high uncertainty rating.

"CEO Jean Pierre Mustier has done very well to stabilize the ship since he took over in 2016. He addressed capital concerns, providing UniCredit with much-needed breathing space," writes analyst Johann Scholtz in his latest report. "The challenge now is to boost revenue and increase profitability to a level exceeding the cost of capital."

Headed by lead manager Jed Weiss, the Silver-rated (and recently upgraded) Fidelity International Growth (FIGFX) favors companies with multiyear structural growth potential in industries with high barriers to entry. Last quarter, Weiss and team tweaked the portfolio's railroad positioning, moving out of U.S. rails and into Canadian rails. They picked up Canadian National Railway (CNR). (The fund already owned Canadian Pacific Railway (CP).)

"Together, they have a duopoly on coast-to-coast rail shipments across Canada as well as important rail routes into and out of the United States," notes management in its latest commentary. "As such, they are unique assets with strong pricing power levered to global trade of a wide variety of goods."

Morningstar assigns Canadian National a wide moat and stable moat trend.

"Canadian National's wide economic moat is based on cost advantages and efficient scale," explains sector director Keith Schoonmaker in his latest report. "We have increased our fair value estimate to CAD 99 from CAD 94 per share to reflect stronger volume growth in 2018-19 than we previously expect--it appears the rail sorted out network congestion faster than we anticipated given the struggle of the fourth quarter of 2017 and first of 2018."

The stock is currently trading in 2-star range, suggesting shares are overvalued.

Susan Dziubinski has a position in the following securities mentioned above: DODFX. Find out about Morningstar’s editorial policies.