Jason Stipp: I'm Jason Stipp from Morningstar. With a lot of market watchers, both hedging for inflation and deflation out there in the marketplace, Morningstar's Paul Larson, Editor of Morningstar's Stock Investor, recently joined us to talk about how you could position a portfolio for both of these uncertainties. He's here today to put some specific ideas behind his advice that he gave last time.
Paul, thanks for joining me.
Paul Larson: Thanks for having me again.
Stipp: So, first question for you, let's just review some of the things you said last time on the inflation and deflation debate. There is one thing that we can sort of agree upon, even if you can't predict which one is going to happen. What is that?
Larson: Well, it is that the tail risk is much larger than it was that the middle part of the probability curve of the bell curve is much smaller and that the tails on that distribution, both for inflation and deflation, the market is worried about both of those things right now.
Stipp: So what they are saying is that the moderation that we see in inflation, there people are expecting less of that and more of one or the other going forward.
Larson: Exactly, that the pendulum is going to swing much more greatly than it has in the past two decades.
Stipp: So last time around you said that looking at wide-moat stocks is a good way to prepare your portfolio for these uncertainties, even if we don't know what's going to happen. So you're going to give us some specific investment ideas behind that. Let's start with the inflation side; there's a lot of folks that have lots of different options for investing and trying to hedge against inflation. What are your ideas?
Larson: Right. Well, I think one of the key things that we want to get across is if you believe that we are going to head into a period of high inflation that you don't necessarily have to go out and buy gold coins to have a good investment.
One investment that looks attractive is Vulcan Materials, and this is the largest aggregates producer in the country. And the reason that Vulcan is attractive from an inflationary standpoint is that if you think that inflation is coming, you want to buy companies that are levered that have debt, because the inflation is going to erode the value of that debt. And you also want to buy companies that produce hard commodities, hard assets, hard money, because the value of that hard money relative to the fiat currency, the paper money is going to increase. And Vulcan definitely scores well on both of those accounts.
For better or for worse, it bought a company called Florida Rock in 2007, took on a lot of debt to buy this company, very bad timing on that acquisition. Unfortunately it's been a painful ride owning this stock. But I think from this point forward with the stock below $40, and our fair-value estimate is $68 that it's an attractive opportunity in and of itself and it does give you that inflation kicker should we go down that path.
Stipp: Certainly good to know there is a valuation story behind that one as well. On the deflation side, and there's been a lot written about this recently, as the market has hit some rough patches and some more uncertainty about the economic environment. What are your ideas for hedging against deflation as a stock investor?
Larson: Right. Well, when you are betting for deflation, you're looking at almost the exact opposite thing. But I think the one key attribute that you want is a company that is going to have an annuity like cash flow stream. And I think one area that is a no brainer here is utilities, and utilities that have regulated businesses, where they have what you call rate-based economics where they invest in, let's say, the transmission grid and then the regulators target a rate that the customers are going to pay that are going to give a return on that investment. That is about as annuity like as you're going to get.
Some specific ideas, one is Westar, ticker, WR. It's primarily an electric utility in Kansas, a well-run operation. Unfortunately, the valuation is not the most attractive today. People have bet up a lot of these deflation ideas, but our fair-value estimate is $27 and the stock is around $24. So, it is mildly undervalued, but in terms of just the characteristics of what you'll look for in a deflation play, this is definitely one of our top picks.
Another idea is actually a Canadian company, it is not a perfect pick, because you'll get that currency exposure, but it is TransCanada, and this is the largest Canadian pipeline company. They are primarily rate based economics up in Canada. They do have some operations in the U.S. Our fair-value estimate here is $43. The stock is around $35. It is a very steady eddy, very stable company; pipelines, other infrastructure assets that are going to give that very steady cash flow, no matter what path inflation, deflation takes.
Stipp: And you said you had a third idea in this space as well?
Larson: Sure, another one is Spectra Energy, and this is a natural gas company here in the United States and this is a company that has natural gas distribution, pipeline assets, also a very large player in natural gas storage and they are a general partner of a master limited partnership, a business model that we like, having that general partner.
It's looking undervalued right now. Our fair-value estimate is $27. The stock is around $21 and it does have a wide moat and it also has fairly decent yield on it. The yield is little under 5% today. So, with those relatively attractive businesses that have that wide moat, that are going - that are infrastructure business that are going to generate cash no matter what path the economy or inflation and deflation take. I think it's an attractive combination.
Stipp: So, definitely keep an eye on that annuity like steady eddy cash flow?
Larson: If for deflation, yes.
Stipp: Sure. Paul, thanks so much for joining me today.
Larson: Thanks for having me.
Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.