Amid the ongoing market volatility, experts say this can be an opportunity to invest in good quality companies at a discount. However, where can investors find good quality companies that are stable enough to invest in?
Investors can identify companies that will provide positive long-term returns through the Morningstar Economic Moat Rating.
An economic moat is a sustainable competitive advantage that enables a company to earn excess returns on capital over the long-term.
Morningstar analysts assign every company they rate an economic moat rating: either wide, narrow, or none. A company whose competitive advantages are expected to last more than 20 years has a Wide Moat; one that can fend off their rivals for 10 years has a Narrow Moat, while a firm with either no advantage has no moat.
We pick five undervalued stocks that have a wide economic moat rating and a stable moat trend, as a reference for investors seeking to cut through the market noise.
Visa (V)
Visa Inc manages payment brands and an ‘open loop’ global payment network, which allows it to provide authorisation, clearing, and settlement of electronic payment transactions.
The firm generates revenue by charging fees to its customers based on the dollar volume of card activity and the number of transactions processed through the network. It connects consumers, businesses, banks and governments in more than 200 countries and territories. The company has a five star rating, which means it is trading at significantly less than its fair value.
Visa is a trusted and popular brand among cardholders and merchants, which dominates the global market for electronic payments. Visa accounts for about half of all credit card transactions and roughly three fourths of debit card transactions in recent years, according to the Nilson Report, a specialist analyst of the payment industry.
A powerful network effect is responsible for Visa's wide economic moat, Morningstar analyst Jim Sinegal says. A payment method widely accepted by merchants is attractive to cardholders, while a payment method used by many cardholders is attractive to merchants. Thus, each additional user of the Visa brand increases its value to others. The company’s ability to deal with hundreds of legal and regulatory frameworks around the world is a significant barrier to entry. Therefore it dominates the digital payment market and it will not be easily toppled.
Payment volume, revenue and income are likely to continue growing at impressive rates for years to come, Sinegal says.
However, the increasing use of mobile technologies will usher in a new payment paradigm at some point, Sinegal adds.
Jones Lang LaSalle (JLL)
Jones Lang LaSalle Inc is a financial and professional services firm specializing in real estate. It operates worldwide, serving real estate owners, occupiers, and investors in roughly 80 countries.
This wide-moat company is well positioned to win a large share of commercial real estate services, Morningstar analyst Stephen Ellis says. It is a market leader with impressive scale and a well-respected brand it has built over the years, plus a shift in business to an area with greater customer switching costs. Ellis thinks it will be difficult for competitors to disrupt the firm's strong competitive position over the coming decades.
In good economic times, the firm is positioned to at least enjoy the normal growth in commercial real estates. And in bad times, it is positioned to win business from weaker or overleveraged peers, Ellis says.
The company finished 2015 with an impressive local currency revenue growth in nearly all of its business segments and geographies despite continued foreign currency woes. Fee revenue was up 15% and 17% for the fourth quarter and full-year 2015, respectively. However, Ellis thinks the firm’s strong performance in 2015 will be hard to replicate going forward, and the strong dollar provides an additional headwind to growth.
McKesson Corp (MCK)
McKesson Corp is a major distributor of pharmaceuticals, specialty drugs, medical and surgical supplies, and health- and beauty-care products in North America. McKesson's technology solutions segment provides software related to pharmacy services, medical records, patient care, and financial management.
McKesson is the largest pharmaceutical distributor by revenue, Morningstar analyst Vishnu Lekraj says. The company’s scale has positioned it favourably with both large drug manufacturers and retail pharmacy customers, which gives it key competitive advantages. Therefore the company has a wide economic moat rating and stable moat trend ratings.
Also McKesson recently acquired Europe's largest drug distributor and second-largest retail pharmacy chain, Celesio. Morningstar analysts believe this strategic move is largely positive, as it will allow the firm to expand into the mature European pharmaceutical market and give it some geographic diversification. This acquisition will expand McKesson's pricing power among its suppliers and allow it to tap into a cheaper pharmaceutical sourcing supply line, Lekraj says.
As speciality drug spending continues to increase, Lekraj believes McKesson has an opportunity to capture value from the market and increase their results.
However the company is facing the push for greater drug pricing transparency and increased pricing pressure from payers. If manufacturers and retail pharmacy customers are unwilling to budge from current pricing demands, profits could be squeezed for McKesson.
Pfizer (PFE)
Pfizer Inc is a research-based biopharmaceutical company. It is one of the world's largest pharmaceutical firms, with annual sales close to $50 billion. Prescription drugs and vaccines account for the majority of sales. The company’s size establishes one of the large economy of scale in the pharmaceutical industry.
Pfizer’s wide economic moat rating is supported by its patent-protected drugs, which carry strong pricing power that enables the firm to generate returns on invested capital in excess of its cost of capital, Morningstar analyst Damien Conover says. Meanwhile, it gives the company time to develop the next generation of drugs before generic competition arises.
As a result, Pfizer's foundation remains solid, based on strong cash flows generated from a basket of diverse patent-protected drugs. Also the company’s powerful distribution network sets itself up as a strong partner for smaller drug companies that lack Pfizer’s resources.
Conover expects the dividend payout ratio will increase during the next several years, with over 3% dividend yield supporting by the stock.
However, the company’s loss of patent protection on several drugs will weigh on future growth. In particular, the 2017 patent loss on Viagra and the eventual 2019 U.S. patent loss on Lyrica will slow long-term growth. The company’s aggressive cost-cutting in research and development could also hurt the long-term prospects of the firm as less capital is available to develop the company’s next generation of drugs, Conover adds.
Monsanto (MON)
Monsanto provides agricultural products for farmers. Its seeds, biotechnology traits, herbicides and precision agriculture products provide farmers with solutions that improve productivity.
Originally a chemical company, Monsanto has morphed into an agricultural giant, focusing on seeds and crop-protection products.
In a major breakthrough, Monsanto introduced the first genetically modified crop seeds in 1996 and has remained the industry leader. The St. Louis-based company generated more than $15 billion in sales during fiscal 2015 and is focused on bringing new biotechnology traits to market to improve farmer yields and productivity.
Monsanto's proprietary seed companies use the traits it develops, but the firm also licenses traits for use by others. This strategy has led to dominant market share, and Monsanto enjoys premium pricing for its patented traits, Morningstar analyst Jeffrey Stafford says. Thus the patented traits form the basis of the company’s wide economic moat rating.
According to Stafford, Monsanto's shares are trading at attractive levels and that some of the near-term headwinds the company is facing today will eventually subside, allowing the market to appreciate the solid long-term prospects of Monsanto's industry-leading seeds and genomics business.
However, negative sentiment around genetically modified seeds could diminish Monsanto’s ability to penetrate new markets, Stafford adds.
