Morningstar equity analysts believe that a company’s intrinsic worth results from the future cash flows it can generate. The Morningstar Rating for stocks identifies stocks trading at a discount or premium to their intrinsic worth, or fair value estimate, in Morningstar terminology. The following four stocks are currently trading at less than their fair value estimate and feature on the analysts’ Global Best Ideas List of undervalued equities.
G4S (GFS)
Global security leader G4S has fallen more than 25% from its 2017 peak on the back of concerns about its India and Middle East business and resultant cuts to full-year revenue growth guidance. However, this division generates just 11% of group revenue and 15% of EBITA, and we believe many of the issues highlighted by investors in this business are short term in nature and do not pose a significant structural risk.
Longer term, we believe the ongoing restructuring program can further simplify the business and remove costs, and structural improvements as the largest players in the industry shift toward higher-value activities should go some way to improving revenue growth and operating margins for G4S. We see material upside to our fair value estimate.
Shell (RDSB)
The shares of Best Idea Shell have performed well, as uncertainty around the safety of the dividend, integration of BG Group, and ability to achieve the company's 2020 free cash flow and return targets have faded. While the past few quarters have disappointed on cash flow, we do not see them as indicative of Shell's long-term potential and think the company is well on its way to achieving its 2020 targets.
Meanwhile, there remains further room for cost-cutting, upstream margin improvement, and reduced capital intensity that should ultimately improve free cash flow generation and drive the shares higher from here.
Vodafone (VOD)
Vodafone is one of the largest wireless carriers in the world, with 275 million fully controlled wireless subscribers and 530 million including joint ventures. While Vodafone has had issues in some countries, such as India and Italy, it is increasing revenue in local-currency terms in most markets. Its reported revenue has been hurt by currency moves as the euro has strengthened against most of the currencies where it has operations.
We think the stock has significantly oversold relative to the issues it has faced. In the meantime, the stock yields 7.9% while shareholders wait for a turnaround, and we believe the dividend is safe. The company has been focused on moving from a wireless-only provider to a provider of converged services.
In Europe, fixed-line telecom services now accounts for about 30% of revenue. We expect fixed-line service revenue to continue to grow faster than wireless services, so this percentage should continue to increase. Fixed-line revenue also tends to be more stable. On the wireless side, Vodafone continues to transition customers to smartphones and 4G technology, both of which generally lead to higher data usage and higher revenue. We believe this trend will continue.
WPP (WPP)
WPP, the world’s largest ad holding company, is on our Best Ideas list as we think the stock’s decline due to disappointing 2018 results and the resignation of CEO Martin Sorrell earlier in the year has created an attractive entry point for this narrow-moat name. The shares are trading at a discount to our £14.50 fair value estimate. At current levels, WPP's dividend yields 7%.
In September 2018, WPP announced the appointment of Mark Read as CEO, ending the uncertainty that had surrounded the leadership of the company for months after Sorrell’s departure. We think the decision indicated some steadiness for WPP as Read has been with the company for over 15 years.
At the same time, we believe Read will instil more of the necessary technology-driven creative thinking into the company as he was also the CEO of WPP's Wunderman, which is one of WPP's strongest digital agencies, utilising data to add more value to and enhance the effectiveness of the agency's creativity.
Read served as co-COO for five months after the departure of Sorrell in April. We remain bullish on the stock for a few reasons. First, we continue to rate WPP with a narrow moat as its brand equity and the strong reputations of its ad agencies are based on the quality of services and not necessarily Sorrell’s leadership. We are confident that the brand equity of WPP and its agencies remains strong.
While organic growth numbers have been disappointing, we might see improvement during the next one to two years as indicated by WPP’s year-to-date big account wins and losses. Based on the firm’s numbers for the first three quarters of 2018 and our estimates, the wins represented around 34% more advertising billing than the losses. Second, with new leadership, the firm may implement some strategies a bit more quickly. They include possible sales of some of its assets such as the custom research side of the data investment management business and more aggressive integration of creativity and media with data analytics.
We note that while WPP is still working on this integration, its peers have had at least a 24-month head start. Last, although WPP is losing some market share, we think down the road, after successfully integrating its platforms, it will have a chance to regain some share during additional account reviews and opportunities. We note that the top ad holding firms; including Omnicom, Publicis, IPG, and the largest, WPP, continue to be the main ones pitching to the biggest advertisers.
