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3 Big Moat Rating Changes From 2014

Jeremy Glaser
Elizabeth Collins, CFA

An earlier version of this video inaccurately reported that Illumina had been upgraded from narrow to wide moat. It had been upgraded from none to narrow.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Elizabeth Collins. She is our director of equity research for North America. We're going to look at some prominent moat rating changes that occurred last year.

Elizabeth, thanks for joining me.

Elizabeth Collins: Thank you, Jeremy.

Glaser: Let's start with an upgrade from narrow to wide--Mead Johnson (MJN). What prompted that change?

Collins: Well, really looking at the brand loyalty. Mead Johnson does nutrition for babies and toddlers and young kids. And once parents choose an infant formula, they are very loath to just switch--in fact, they become more of an early lifetime customer. They go from the infant formula and then through the toddler foods, and this allows Mead Johnson to charge a very pretty premium to other offerings out there.

Glaser: De La Rue (DLAR) is a European company that specializes in currencies--creating currencies for countries. We downgraded that moat from wide to narrow. What do we think changed in that business?

Collins: A couple of things. One, we see that their customers, which are large governments, have bargaining power. If De La Rue messes up or charges too much, the governments can always insource what they had outsourced to De La Rue. They can print their own money, literally--not just figuratively.

Secondly, we see two secular trends that see De La Rue's competitive position potentially weakening within the next 20 years, which is why we downgraded it from wide to narrow. One is that we see governments interested in more plastic money, which is introducing more competition to cotton or paper money, because plastic money is more durable. Secondly, we're going to be using less physical money in the future, so there's less of a need for printed money in the future. And that should see competitive threats as well.

Glaser: Finally, another downgrade, POSCO (PKX), a South Korean steelmaker. Why do we think that this went from a rare basic-materials company with the moat to one without a moat?

Collins: POSCO had great facilities. They were built by essentially the South Korean government. They were very efficient, low cost, and near growing markets. Now, we've seen that competitors have caught up with their own efficient steel plants. And we see that the outlook for demand is not strong enough, so the cost curve is becoming less favorable and POSCO just isn't as competitively advantaged as it once was.

Glaser: Elizabeth, thanks for your take on these changes today.

Collins: You got it, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.