The current stock market meltdown has taken down many companies’ share prices to multi-year lows as investors panic about the coronavirus impact. The FTSE 100 is now at an eight-year low and it seems no company is safe from the sell-off.
Many of these companies are highly rated by Morningstar and have a long history of generating high profits and dividends for investors. But at times of severe market dislocations many shares’ valuations are punished across the board. Those exposed to the fortunes of the global economy have been the most affected in the recent sell-off, for example oil companies. But could the indiscriminate selling offer an opportunity?
Look for a Moat
Morningstar uses the concept of an “economic moat” or competitive advantage to select companies that are likely to outperform. Britain’s two largest oil companies BP (BP.) and Royal Dutch Shell (RDSB) have been in the firing line since the coronavirus outbreak and the double-whammy of the oil price war. Shares have collapsed since the start of the year: BP is down 47% to 254p and Shell is 52% lower at £10.72. Both companies are now trading as five-star stocks under Morningstar methodology, which means they are trading significantly below their estimated fair values: in BP’s case, the current share price is 257p, against analysts’ fair value of 610p, a 58% discount.
Shell, meanwhile, is trading just above £10 per share, against a fair value of £27 - a staggering 63% below the company’s fair value. Both stocks are considered to be “narrow” moat companies in that they have a competitive advantage but there is significant risk attached to investing in oil companies in the short term, according to analyst Dave Meats. A dividend cut announcement from either BP or Shell would likely put further pressure on share prices.
With markets so volatile, it’s difficult to assess whether the plunge in share prices present a “buying opportunity” or if prices will lurch even lower. What we are highlighting is that the sharp fall in these company’s share prices puts them into the “most undervalued” category of all the firms we cover. As Morningstar head of European equity research Alex Morozov points out, the “uncertainty” rating is an added element in the mix, meaning that revenues or cash flows are likely to be very volatile in the near future.
BT Under Pressure
BT's (BT.) share price has been under pressure since before the sell-off – expectations of a dividend cut and the prospect of being nationalised under a Labour Government have weighed heavily on the shares. Now, the cancelling of live football games is expected to hit revenues this year. Shares in the broadband provider and sports broadcaster started the year at 192p and are now around 100p, a 47% fall. The company is now a five-star stock with a narrow moat, according to Morningstar analysts.
There are eight other companies which are both rated five stars and have a narrow economic moat, including cruise operator Carnival (CCL), catering firm Compass (CPG), aerospace company Meggitt (MGGT), airline engine maker Rolls-Royce (RR), packaging firm Smiths (SMIN), Vodafone (VOD) and WPP (WPP).
Five-star rated companies with a “wide” economic moat are much harder to come by; just two UK listed stocks under Morningstar coverage have both qualities and these are both tobacco firms: Imperial Tobacco (IMB) and British American Tobacco (BATS). The two have also been caught up in the sell-off, but have not fallen by as much as the FTSE: Imperial is off 25% in the year to date and British American Tobacco is 22% lower than it started the year, while the FTSE 100 has fallen nearly 35%. These two companies also have a "low" uncertainty rating.
Morningstar’s Philip Gorham updated his note on BATS at the end of February, at the time of the initial market volatility: “The stock is materially undervalued in our opinion, and we think the market is pricing in too pessimistic a scenario.”
