Morningstar equity analysts removing Kingfisher (KGF) from our Best Ideas list in light of the heightened uncertainty generated from Britain’s vote to leave the European Union. We still believe in the margin expansion story, particularly as many of the gains should come from internal measures such as rationalising the merchandise range across markets.
However, the decision to leave the EU creates degree of uncertainty that could discourage investment in housing construction and dampen the housing market, particularly in the Southeast, and this could weigh on same store sales in the B&Q and Screwfix banners, which collectively account for 40% of Kingfisher’s sales. Both a slump in consumer confidence and the potential for interest rate increases to offset the inflationary impact of the depreciation in the pound pose threats to the housing market, and we think it is prudent to adopt a wait-and-see approach to Kingfisher until visibility into the housing market improves.
We 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. Five-star stocks sell for the biggest risk-adjusted discount to their fair values, whereas 1-star stocks trade at premiums to their intrinsic worth.
Four key components drive the Morningstar rating: our assessment of the firm’s economic moat, our estimate of the stock’s fair value, our uncertainty around that fair value estimate and the current market price. This process ultimately culminates in our single-point star rating. Underlying this rating is a fundamentally focused methodology and a robust, standardized set of procedures and core valuation tools used by Morningstar’s equity analysts.
P&G Remains a Top Idea Despite UK Exposure
Procter & Gamble (PG) remains an attractive investment idea, even after the news that Britain intends to exit the European Union, in our opinion. P&G derives around one-quarter of its sales from Europe, but we estimate just a low-single-digit percentage of its consolidated total from the U.K. While the potential impact of Brexit is far from clear at this juncture, we don’t expect it will materially impeded P&G’s performance or wide-moat, given its vast scale, its portfolio of leading brands, and its entrenched relationship with retailers.
Further, we continue to believe that the market's confidence in P&G’s competitive edge and ability to drive accelerating sales growth has yet to materialise. We stand by our contention that P&G's strategic effort to rightsize its brand mix is a wise course, highlighting that the firm aims to become a more nimble and responsive operator without sacrificing its scale and negotiating leverage with retailers.
We think this should ultimately enable P&G to increase its focus on the highest-return opportunities, which is critical in the intensely competitive environment in which it plays. P&G is also driving efficiency gains with its current cost-saving initiative by reducing overhead, lowering material costs from product design and formulation efficiencies, and increasing manufacturing and marketing productivity.
Overall, we think the combination of these initiatives will enable P&G to up its core brand spending behind product innovation and marketing to combat competitive pressures while resulting in improved profitability. However, we expect these efforts to play out over the next few years rather than a couple of months, and as such, we look for the firm to drive profitable growth longer term, despite muted progress to date.
