3 Competitive Stocks to Consider

Last month, Morningstar's equity research team initiated coverage of one of this year’s most-discussed IPOs, Palantir. We think that the company has carved out significant competitive advantages, and we expect it to outearn its cost of capital over the next decade. We’ve therefore assigned it a narrow Morningstar Economic Moat Rating.

Our analysts have picked up coverage of two other companies recently that we also think have developed sizable competitive advantages. We've assigned these companies narrow and wide Morningstar Economic Moat Ratings.

Here’s what our analysts had to say about all three names when initiating coverage. Notably, two of the stocks are undervalued according to our metrics as of this writing.

Palantir Technologies PLTR Economic Moat Rating: Narrow Moat Trend: Positive Morningstar Rating (as of Oct. 21, 2020): 4 stars

“We are initiating coverage of Palantir Technologies with a $13 fair value estimate, equivalent to a $28 billion market capitalization (assuming 2.17 billion shares), along with narrow-moat and positive-moat trend ratings.

In our view, Palantir is well suited to help organizations consolidate and harness the power of the data generated. Palantir sells two software platforms aimed at solving big data integration and analytics challenges for government and commercial clients. We believe its software becomes mission-critical to organizations, creating resilient customer switching costs. Additionally, we opine that Palantir benefits from unique intangible assets developed into its offerings, and a network effect from its software becoming more useful as more companies and users join the network.

Between a leading position in the government sector with the U.S. and its allies and the opportunity for Palantir to expand into commercial enterprise applications, we think the company is poised for robust growth and margin expansion in the years ahead. We believe a robust growth trajectory comes from new commercial ventures on top of a strongly expanding government base, and that installation efficiencies and the strategic shift toward a SaaS model will be conducive to margin expansion throughout the 2020s." Mark Cash, analyst

Vontier VNT Economic Moat Rating: Narrow Moat Trend: Stable Morningstar Rating (as of Oct. 21, 2020): 4 stars

“We are launching coverage of Vontier, a diversified industrial technology firm focused on transportation and mobility solutions, with a narrow moat, stable moat trend, and a $38 fair value estimate. We see shares as undervalued as Vontier is trading in deep 4-star territory. The current stock price implies an enterprise value to 2021 EBITDA multiple of around 9 times, well below the average 14 times enterprise value to 2021 EBITDA multiple for its peer group, in which we include Dover, Franklin Electric, Snap-on, and Stanley Black & Decker.

Following its spin-off from Fortive on Oct. 9, Vontier retained the transportation technologies and franchise distribution businesses, including Gilbarco Veeder-Root and Matco Tools. Vontier’s business model is an iteration of the Danaher Business System playbook, which the firm inherited from its former parent companies, Danaher and Fortive. Vontier Business System focuses on acquiring moat-worthy companies, boosting their operating margins through continuous improvement, and reinvesting cash flows into further M&A deals.

While we expect M&A to remain an integral part of Vontier's strategy, we believe that the underlying businesses in the firm's portfolio have established narrow moats based on intangible assets and customer switching costs. Vontier enjoys strong market share in both of its business lines, as Gilbarco Veeder-Root is one of the top two players in the retail fueling space (alongside Dover) and Matco is one of the top three players in franchise-based tool distribution (alongside Snap-on and Stanley Black & Decker's Mac Tools brand). Vontier's large installed base of equipment generates a healthy stream of recurring revenue, which accounts for a mid-20s percentage of the firm's sales. The firm's economic moat helps it generate strong operating margins in the low 20s, and we believe that Vontier is well positioned to outearn its cost of capital over the next decade." Krzysztof Smalec, analyst

TransDigm Group TDG Economic Moat Rating: Wide Moat Trend: Stable Morningstar Rating (as of Oct. 21, 2020): 3 stars

“We initiate on TransDigm Group, a diversified aircraft supplier with high aftermarket content, with a fair value estimate of $468 per share, a wide moat rating, a high uncertainty rating, and an Exemplary stewardship rating. Our fair value estimate implies a price/fiscal 2021 earnings multiple of 38.4 times, and we see the shares as roughly fairly valued, but we would not hesitate to recommend the stock in the event of a material pullback. Broadly, we think TransDigm is a high-quality firm that follows a simple, consistent strategy: Acquire companies that provide proprietary, sole-source components that are repaired in the aftermarket frequently. The firm then improves operations by increasing prices for spare parts, among other things. This strategy works because Federal Aviation Administration regulations require potential competitors to be certified as identical to the original part, which is difficult without the proprietary design. The FAA also requires that the passenger aircraft be maintained to type-certificate standards, so customers have highly inelastic demand.

The biggest risk we see to the firm from the pandemic is the potential for airlines to retire older, higher-maintenance aircraft in favor of newer, lower maintenance aircraft to reduce operating expenditures. It is difficult to estimate the extent to these headwinds, but we think it will depend on the extent to which airlines increase capacity during the summer of 2021 when Morningstar anticipates a vaccine will be broadly available. If there is a substantial, rapid increase in demand, airlines would be less able to retire older aircraft." Burkett Huey, analyst