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Scouting for Investments Abroad

Use this screen to find firms that add geographic diversification.

David Krempa, 12/01/2011

Because the focus is on China this issue, we thought it would be worthwhile to search for safe investments that can increase investors’ foreign exposure. Understandably, U.S. investors’ portfolios are often overconcentrated in domestic companies. Investors are much more familiar with U.S. companies, so it makes sense that they would gravitate toward the stocks they know. Exposure to foreign companies, however, helps diversify portfolios and gives investors exposure to fast-growing economies. Foreign companies are rarely highlighted in the U.S. financial media, so unless investors are actively searching for foreign investments, they are unlikely to come across new ideas.

Given the situation in Europe, many investors may be concerned about investing in foreign companies. Most large U.S. firms, however, already have significant European and international exposure, so investing in a foreign firm may not be as radical of a change as it seems. Also, Europe is a large part of the global ex-U.S. economy, but there are a number of other countries, including those in emerging markets, that have been producing strong growth and are in solid financial shape. We believe that investors with a long time horizon will do well by investing in attractively priced international firms that have competitive advantages, even if they are heavily dependent on Europe.

Foreign = Yes

Morningstar Principia does not have the option to screen by individual country, but it does allow us to limit our stock screen exclusively to firms that are based outside the United States. This screen will cut down our stock universe from more than 11,000 companies to around 2,200 stocks.

And Uncertainty = Low

Many investors are skittish about investing in foreign firms for a number of reasons. They’re less familiar with foreign economies, wary of foreign government regulations, and often wonder if the firm’s financial statements are reliable. These concerns have been especially heighted with the recent emergence of some fraudulent firms in China. For these reasons, we limited our screen to firms that our equity analysts have assigned a low uncertainty rating. Firms with low uncertainty tend to be larger, more established, less cyclical, and generally safer investments than those firms with high uncertainty. They are firms that we believe are the least susceptible to political instability. This may restrict us from getting home-run returns, but it will help protect our downside.

And Moat = Narrow or Wide

We also limited our search to companies that Morningstar has assigned a narrow or wide moat. The firm’s moat is an indication of the firm’s sustainable competitive advantage, meaning they are likely to keep competitors at bay.

And Star Rating > 2 Stars

We restricted our search to only stocks that Morningstar’s equity analysts rate 3 stars or higher. Morningstar’s ratings are calculated based on analysts’ estimate of the business’ intrinsic value in relation to the current stock price, with the most undervalued stocks receiving 5 stars and the most overvalued stocks receiving 1 star. By eliminating the 1- and 2-star stocks, we avoid firms that Morningstar’s analysts believe are currently overvalued.

We ran this screen in October. Here are some of the results:

Novartis AG NVS
Within the big pharma industry, Novartis is one of the best-positioned companies for growth. Novartis is in front of all the positive tailwinds moving the group over the next decade. In particular, Novartis holds an industry-leading position in emerging markets, which should help the company capture strong future demand from these fast-growing countries. The company’s entrenched vaccine platform should benefit as pricing power has returned to new vaccines. Novartis’ generic division, Sandoz, should benefit from patent losses on major blockbuster drugs as well as strong international demand for generic drugs. Further, the company’s strategy of targeting unmet medical needs with its drug pipeline should yield several drugs with strong pricing power. Considering the company’s relatively modest patent exposure, Novartis should see a fairly stable growth over the upcoming years relative to its competitors.

Diageo PLC DEO
Diageo’s long-term financial performance looks bright because its vast distribution network, including some exclusive distribution agreements in the United States, would be very difficult and expensive for rivals to replicate. The firm’s beer portfolio should position Diageo well to exploit migration to branded alcohol in emerging markets such as Asia and Africa, while its unmatched spirits portfolio should allow it to benefit from premiumization across the globe. In our opinion, these competitive advantages and growth opportunities justify an earnings multiple valuation slightly above the market average. With around one third of its volume derived from maturing products, it will be many years before rising input costs affect the income statement, making Diageo somewhat protected from today’s cost inflation.

We regard Nestle as a proxy for the consumer staples industry, not as a health food company. Its vast geographical footprint and diverse product portfolio spanning packaged food, beverages, pet care, and nutritional and pharmaceutical products mean that new product launches will barely move the needle on Nestle’s top line, and the firm’s equity is unlikely to be a home-run investment, particularly as it is currently trading at our fair value estimate. For investors wishing to gain broad exposure to the consumer staples industry, however, Nestle could be an appropriate holding.

Unilever PLC UL
Unilever soared through fiscal 2010 relatively unscathed. We have been particularly encouraged that investments in research and development are yielding measurable results, as management estimates that about one third of its consolidated sales were generated from products launched in the past two years. However, Unilever’s current strategy of extending the distribution of these new offerings to multiple markets in quick succession may not be a wise move, in our view. Consumers around the world possess different tastes and preferences, and as a result, we believe that tailoring offerings to meet consumers’ varying needs is more appropriate. Given the competitive nature of the categories in which the firm competes (like fabric care), a “one-size fits-all” strategy could ultimately backfire on Unilever.

Enbridge Inc ENB
Enbridge offers a rare combination of size, diversified low-risk cash flows, strategically positioned assets, and attractive growth prospects. We think management’s expected 10%-plus earnings per share growth for at least the next five years is reasonable thanks to a history of execution and abundant opportunities in oil, natural gas, and green energy. Visible growth opportunities and the stable nature of Enbridge’s cash flows command a premium valuation relative to peers with more commodity exposure, in our view. Beyond CAD 6 billion of projects secured for after 2012, we see significant growth opportunities in the oil sands, the Bakken, a potential crude oil line from Cushing to the Gulf of Mexico, natural gas infrastructure in BC shale plays, and international acquisitions. Despite recent media hype and protests, we still think Northern Gateway will be approved based on sound economics and the new conservative majority.

David Krempa is an associate analyst with Morningstar.

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