February’s edition of the Morningstar Europe Core Pick List features the most attractively valued European-domiciled companies that possess sustainable competitive advantages. This month’s list saw a high amount of turnover relative to last month. Changes in fair value estimates and trading fluctuations caused several firms to drop off the list and others in our coverage universe to be added.
The Morningstar Europe Core Pick List features the most attractively valued European-domiciled names with sustainable competitive advantages, or economic moats. Morningstar equity analysts’ top picks across each sector are chosen based on their uncertainty-adjusted discounts to their intrinsic value.
The Core list only includes European companies with: a market capitalisation of at least $1 billion, narrow or wide economic moats, a fair value uncertainty that is not very high or extreme and a minimum of one company from each sector, with a maximum of three companies in any one sector.
New additions to the list this month include consumer cyclical stocks Industria De Diseno Textil and Publicis Groupe, brewer Anheuser-Busch InBev, healthcare stock Shire, industrial company Meggitt, and technology company SAP. Of these names, both UK companies Shire and Meggitt specifically represent some of the cheapest European names on an uncertainty-adjusted, price/ fair value basis; both currently trade at 15%-plus discounts to their respective fair value estimates.
Two New UK Stocks Make the List
Narrow-moat-rated Shire (SHP) is a diversified, Ireland-based specialty drug firm. It has primarily grown through mergers and acquisitions, including the Transkaryotic Therapies acquisition in 2005, which established its genetic disease business with Replagal and Elaprase, as well as the merger with New River in 2007. The New River merger brought full rights to neuroscience drug Vyvanse.
Analyst Karen Andersen lowered her fair value estimate in the name following Roche’s positive data for Hemlibra in haemophilia A and the failure of Shire’s Hunter syndrome drug in phase three. She now assumes Advate declines 10%-15% annually beginning in 2019 as Hemlibra launches in the noninhibitor population.
Andersen further forecasts that Shire’s main revenue contributor, Vyvanse, will grow to $3.2 billion in sales by 2022, despite her expectation that its European rollout will be much slower than in the United States and will offer significantly lower peak sales. As it has historically, Shire continues to rely on acquisitions to supplement its portfolio, and while she remains sceptical of the Baxalta acquisition due to serious competitive threats in haemophilia, Andersen points out that other recent deals have been beneficial to the firm’s growth and competitive advantages.
Narrow-moat-rated Meggitt (MGGT), headquartered in the United Kingdom, is another new addition to our list of undervalued names. The firm specialises in smart engineering of critical components and subsystems within civil aerospace, military, and energy applications. Meggitt’s aircraft braking systems business, which comprises about a fifth of the company’s sales, is a market leader in military, business aviation, and regional aircraft.
Morningstar equity analyst Jeffrey Vonk likes the firm’s strong positions on aircraft such as the Bombardier C Series, numerous helicopters, and the F-35 fighter aircraft. Once an aircraft is delivered, the owner typically uses the original equipment manufacturer for maintenance of mission-critical components, such as wheels and brakes.
Moreover, Vonk believes that Meggitt’s positions on helicopters, which use large amounts of dynamic parts, and on regional jets, which land three times more often than wide-body commercial transports, enable the company to drive significant aftermarket revenue. Finally, as Meggitt’s high R&D investment phase ended in 2016, Vonk expects increased profitability and returns, despite his weak short-term delivery expectations for helicopters and business jets. These and the remainder of our top picks for each sector for February 2018 are listed here. From a price/fair value standpoint, the overall list changed appreciably, with an average increase of about 183 basis points.
As it has for quite some time, the healthcare sector continues to trade at the most appreciable average uncertainty-adjusted discount, followed by industrials and communication services. As was the case in recent past issues, only one technology and energy firm made the list this month.
