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By Matthew Coffina, CFA | 02-24-2015 03:00 PM

Notable Stock Rating Changes

Hear about Morningstar's latest take on energy stocks, the cost of equity, and real estate portals.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Matt Coffina--he is the editor of Morningstar StockInvestor newsletter--to look at some notable equity ratings changes.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start with energy. What kinds of changes have we seen to fair value estimates or moat ratings in the energy sector with the oil-price slide?

Coffina: Some of the changes we have seen were, for example, a dramatic cut in our fair value estimate for Core Laboratories (CLB). I think we were just much too optimistic before, even without the slide in oil prices, but the slide in oil prices has really exacerbated the longer-run growth outlook. It's probably not as robust as we had previously believed, and so we cut our fair value estimate pretty steeply there.

Another example would be National Oilwell Varco (NOV). Our fair value estimate has come down but so has our moat rating. By the way, this is a stock we own in our Hare portfolio. We now think the moat rating is narrow instead of wide. We think that the moat trend is stable instead of positive. We even cut our stewardship rating to standard instead of exemplary. And what is really going on with NOV is that this is a company that benefited very much over the past decade from this once-in-a-generation build-out of deepwater rigs that was facilitated by high oil prices but also by the fact that we built very few rigs in the 20 years leading up to the 2000s.

So, after the oil-price crash in the early to mid-1980s, we had an oversupply of high-spec rigs and we built very few rigs for 15 or 20 years there. That meant that the rig fleet was very old going into this upcycle for oil prices, and NOV was able a role up the industry to a significant extent and really take advantage of that. I think this is an example where we maybe mistook a cyclical upswing--and a very prolonged cyclical upswing lasting decade or more--for a secular growth trend. The reality is that in a more normalized environment, especially with oil prices where they are today, our former forecasts for NOV were probably too optimistic.

One other aspect of the story here is that the company is so acquisitive that the balance sheet has really swelled over time, and that has depressed returns even without the oil-price slide. Now, with this new overhang of high-spec deepwater rigs and the oil-price slide, it is going to be much harder for NOV to generate wide excess returns. We think the company can still generate returns above its cost of capital, but we are much less confident that those will be sustained 10 and 20 years into the future, which is really what we require for a wide moat.

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