Five Hidden Stock Gems

Astute Morningstar.com Premium Members may have noticed that, over the past few months, we've been increasing the number of stocks that we cover. As always, when you pan more gravel, you find some gold, so I thought I would highlight for you some of the more interesting companies we've recently brought under coverage.

We spotlighted some of the new wide-moat stocks in our coverage universe a few weeks ago, so I’ll focus on some of the lesser-known niche companies that we’ve started to cover. Most of these do not sport attractive valuations at the moment, but they’re all worth keeping on your watch list.

 Northern Border Partners 
Analyst: Paul Larson
"A pure pipeline company focused on natural gas, Northern Border owns an attractive portfolio of stable assets that generate substantial free cash flow and that are insulated from commodity price swings....We are attracted to pipelines because of their wide economic moats. Rights of way do not come easily, and regulators do not give their approval to new systems or expansions unless there is a demonstrated economic need. Plus, with tariffs regulated, Northern Border's customers have little incentive to switch, and the company's average contract length is in excess of three years....The upshot is that Northern Border's operations generate substantial, predictable free cash flow.” Read the full  Analyst Report.

 Cuno  
Analyst: Eric Landry
"Filters may not be sexy, but they’re a great business, and Cuno holds a strong position in several high-growth segments. We're big fans of this narrow-moat company, and we would load the truck with shares at a small discount to our fair value estimate.

"The nature of the filter business is analogous to the oft-used razor-and-blade model, with highly profitable recurring revenue. Margins are insulated because the product's cost-benefit ratio is heavily skewed in the manufacturer's favor. Filters are very inexpensive relative to their importance in maintaining the integrity of a process, be it drinking-water treatment, semiconductor manufacturing, or even drug discovery. This makes for 'sticky' customers who prefer to buy a brand they know and trust rather than save a few pennies. In 2003, about 75% of Cuno's revenue came from high-margin replacement business, a primary reason for our narrow-moat rating." Read the full  Analyst Report.

 HCC Insurance Holdings  
Analyst: Dreyfus Neenan
"There's a lot we like about HCC. A specialty niche insurance business with medium-size entry barriers, sensible acquisitions, and a growing franchise in insurance services give HCC a narrow moat and attractive prospects.

"We like HCC's strategy of focusing on specialty insurance in niche markets where competition is lower, thanks to entry barriers. HCC's products insure unusual risks such as individual disability for high-profile athletes, vintage military aircraft, and contest indemnification. Insurers can't profitably underwrite these risks without specialized knowledge. And it can be too expensive for all but the largest insurers to learn; losses will be infrequent, but large.” Read the full  Analyst Report.

 NSTAR  
Analyst: John Kearney
“A low-risk business model, growing dividends, and solid shareholder returns are just three of NSTAR's attractive qualities.

"NSTAR is the closest thing to a pure-play transmission and distribution (T&D) company that we have seen in the electric-utility industry....NSTAR's regulated subsidiaries contribute nearly all of the company's earnings, providing safe and highly predictable cash flows.

"NSTAR's T&D-only business model strips out some of the risk and capital intensity that often characterize utilities with generation facilities. Even though it must purchase energy from outside generating companies, like most regulated utilities, NSTAR can recover its energy costs by passing the expenses directly through to customers. Thus, energy price fluctuations do not affect the company's operating income. NSTAR serves an attractive customer base, with residential and commercial segments accounting for the majority of revenue. More-volatile and lower-margin industrial customers account for less than 10% of sales.” Read the full  Analyst Report.

 Commerce Bancorp 
Analyst: Jim Callahan
"Commerce Bancorp has built an impressive--but not bulletproof--banking model....The company's deposit-gathering ability is an unquestionable competitive advantage, but we're stopping short of a wide-moat rating for now....Commerce has a strong record and distinctive corporate culture--both potential wide-moat traits--but we're not yet sold on the sustainability of its business model, which is a key requirement of wide-moat status....In short, Commerce Bancorp is an incredible deposit gatherer, but several potential risks mean we'd wait for a relatively substantial discount to our fair value estimate before considering the shares." Read the full  Analyst Report.