At Morningstar, we're fans of companies that have carved out economic moats thanks to the unassailable competitive advantages they possess. These competitive advantages can be derived from various sources such as intangible assets, switching costs, network effect, cost advantage, and efficient scale. We expect narrow-moat companies to generate excess returns on invested capital for at least the next decade; for wide-moat companies, that stretches to least 20 years.
But that doesn't mean that no-moat stocks aren't worth investing in. Some companies--such as automakers--are in industries that aren't moat-friendly. Others, meanwhile, are in the process of trying to build moats.
For those investors who'd like to expand their portfolios beyond moat stocks and investigate some new ideas, here are a handful of attractively priced no-moat stocks with positive moat trends. A positive moat trend indicates that a company's sources of competitive advantage are growing stronger. These stocks are all trading in 4- and 5-star range as of this writing.
These companies may not be moat-worthy today, tomorrow, or even the next day, but they're heading in the right direction. And they're inexpensive relative to what we think they're worth.
Unlike traditional asset managers, AMG doesn't directly manage investments; rather, it invests in successful boutique asset managers, taking a revenue cut in return. Affiliates operate independently, with AMG lending a hand with operations and marketing. As a result, the affiliates, not AMG, enjoy most of the operating leverage that's inherent in the asset-management business, which is why it doesn't currently earn an economic moat while most traditional asset managers do.
"While AMG has been able to compensate for its lack of operating leverage with financial leverage, believing that its ability to secure inexpensive capital provides it with a significant competitive advantage, it falls short of what's required for an economic moat," says sector strategist Gregg Warren.
Morningstar does, however, assign AMG a positive moat trend. AMG boasts a diverse product mix, is slightly more global than its peers, and its product distribution is more heavily weighted toward institutional and high net-worth clients, which tend to be stickier than retail investors, notes Warren. Plus, competition for investment in boutiques is quite low, and AMG has a pipeline of potential investments where it's viewed as the buyer of choice.
"At this point, we believe it would be difficult for another firm to replicate much of what AMG has created with its business model," says Warren.
Insurers don't benefit from good competitive positions. Competition is fierce, and the products they sell are commodity-like. Not surprisingly, American International Group, one of the largest insurance and financial services firms in the world, doesn't have a moat.
The company has its strengths, though.
"It is among the largest commercial P&C underwriters, which means that it should be able to leverage its proprietary database to better price and select risks than smaller peers, and recent investments in technology should allow it to better exploit this potential advantage," notes senior analyst Brett Horn in his latest report. Further, AIG has a large global footprint, which provides an advantage when it comes to netting business from global firms. However, adds Horn, the giant's diversification makes it difficult to consistently beat industry returns.
Morningstar assigns AIG a positive moat trend. The company has slimmed down and simplified its operating structure since the financial crisis, says Horn. Moreover, it has abandoned its growth focus (which led to many of the problems the company faced during the financial crisis) and has refocused on risk-adjusted returns and operational efficiency.
"We continue to have confidence in [CEO Brian] Duperreault's ability to move the company toward acceptable results over time and believe the current market valuation offers a reasonable margin of safety," concludes Horn.
Cenovus Energy is an integrated oil company that creates value through the development of its oil sands assets. The firm doesn't earn an economic moat today because oil sands development projects are costlier than conventional oil projects, requiring high levels of capital spending, coupled with high operating and maintenance costs.
"Under the current extraction process, the combination of intensive capital requirements, high transportation costs, low price realizations, high break-even prices, and delay in implementing solvent-aided production hampers Cenovus' ability to generate excess returns on invested capital when we reach our midcycle price forecasts," says analyst Joe Gemino in his latest report.
However, Cenovus has come up with a solution for its solvent-aided process that should allow it to generate the cost savings it needs to better compete with other marginal supply sources. It’s also why Morningstar assigns Cenovus a positive moat trend.
"With the company's research ahead of its peers, the resource potential to showcase its low-cost SAP technology, and project break-evens among the lowest in the oil sands industry, Cenovus' SAP technology will give Cenovus a cost advantage over peers," says Gemino. "We believe the stock is vastly undervalued and presents an attractive opportunity for long-term investors."
DT is not only the incumbent telephone operator in Germany, it's also one of the largest operators in Eastern Europe and one of four national wireless operators in the United States via its stake in T-Mobile US (TMUS). Overall, the company generates strong free cash flow, notes senior analyst Allan Nichols in his latest report. And it has used that cash to expand into other countries.
"The firm still has room to grow in several markets, and we expect it will continue to invest in these areas," says Nichols.
Despite the company's inherent advantages, though, it doesn't earn an economic moat today. It hasn't been able to use its scale to generate returns on investment above its cost of capital--a must for moat-worthy companies. Yet the company's moat trend is positive for several reasons. For starters, says Nichols, the company is addressing its cost structure by reducing head count and selling less profitable businesses. Moreover, it merged its troubled U.S. unit with MetroPCS to create T-Mobile, providing a potential exit strategy. Lastly, its Greek operation, OTE, has successfully sold several divisions.
"As these extra investments are reduced, there is a chance DT will be able to exploit its market share and raise its return on capital to a point where it will deserve a narrow moat," concludes Nichols.
Goldcorp is a senior gold mining company with operations in Canada, the U.S., Mexico, and Latin America. Morningstar doesn't assign the company an economic moat largely because, as analyst Kris Inton explains in his latest report, the company has fueled its prolific growth through fully priced or overpriced acquisitions.
"As a result, we think it is unlikely that the firm will generate economic returns in excess of its cost of capital, barring a return to materially higher gold prices," he says.
And Morningstar's doesn’t expect materially higher gold prices any time soon. In fact, Morningstar forecasts gold prices to fall to $1,150 per ounce by the end of 2018. When real rates rise, says Inton, gold prices fall.
"We think it is only a matter of time before gold investment adjusts to the higher opportunity cost, leading not only to slowing investment demand, but also to a potential outflow of gold from ETFs back into the gold market." Morningstar forecasts nominal gold prices to reach $1,300 per ounce by 2020, with Chinese and Indian jewelry demand filling the gap left by waning investor demand.
That said, Morningstar assigns Goldcorp a positive moat trend rating. Inton expects the company's costs to decline further as some of its low-cost mines ramp up in the next few years.
Susan Dziubinski does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.