We Visit Three Wide-Moat Companies

Here at Morningstar, our team of 100-plus stock analysts spend a lot of time hitting the pavement to research further the companies that we cover. Below are notes and insights from three recent visits to firms we believe have wide economic moats. (All three companies are on our watch list of wide-moat firms inside our StockInvestor newsletter.) 

 Cintas (CTAS)
Morningstar Rating: 3 Stars
Economic moat: Wide
Business risk: Average
From analyst Joel Bloomer: Recently I had the chance to spend a day with members of Cintas' CTAS management team and tour two facilities in the Cincinnati area. My primary goal was to gain a better understanding of the competitive advantages that contribute to Cintas' wide moat. Here's what I found.

A recurrent theme in my discussions with Bill Gale (CFO) and Mike Thompson (vice-president and treasurer) was scale. As a leader in uniform rentals and sales and an upcoming player in several other industries, Cintas has plenty of scale. Why is this important? Scale allows for discounts when purchasing fabrics, fuel, and other inputs to production. Scale also justifies large capital outlays on machinery (massive washers and dryers) and technology (handheld devices on routes) that eventually return their cost and more through efficiency gains. And finally, scale allows for the development of a specialized salesforce, while competitors primarily rely on their drivers to create new business.

These factors culminate in Cintas' substantial 6-percentage-point operating margin advantage over its closest competition. In isolation, each cost savings doesn't amount to much, but 50 basis points here and 50 basis points there obviously add up. Although I was already aware of the perks that scale provides, by witnessing a few of Cintas' many impressive distribution and servicing facilities for myself, I have a better sense of what it would take to traverse Cintas' economic moat.

I was also pleased to hear more about the long-term focus of Cintas' executives and plant managers. They think in years, not quarters, which coincides well with Morningstar's investment philosophy. Given Cintas' considerable head start and solid plans for the future, I expect it to remain ahead of the competition for many years to come.

 Harley-Davidson (HOG)
Morningstar Rating: 3 stars
Economic moat: Wide
Business risk: Average
From analyst Marisa Thompson: Our recent visit with Harley-Davidson's management team in Milwaukee included a tour of its headquarters, dealer repair university, and powertrain manufacturing operations. Managers agreed with us that the aging of the baby boomers was an issue for Harley-Davidson and acknowledged that sales growth will be slower in the future. However, they gave a number of reasons why Harley will weather this generational storm well.

First, the aging of the baby boomers has shifted demand to larger, high-margin touring bikes, catering to older, more wealthy riders. At the same time, Harley continues to upgrade models and features (while holding price increases below inflation) to keep Harley enthusiasts excited and bring in the next generation of riders. True to its wide-moat status, Harley's base of supporters remains highly loyal to the brand, including the dealerships, of which 82% sell only Harley bikes. In addition, international sales are brisk since Harley began better targeting overseas markets by revamping its model lineup and distribution while expanding dealerships abroad (more than 60% of which are exclusive).

As we talked with engineers during the factory tour, it appeared that the firm continues to find ways to do things more efficiently. Harley utilizes a combination of skilled labor and robotic equipment to manufacture and assemble powertrains. Engineers emphasized that skilled labor remains a key asset because people are more flexible than robots that have to be reprogrammed in order to change the way they work. Harley tends to use robots to machine parts that are standardized across all models.

The company's tight-knit operations in areas from marketing to engineering mean that Harley continues to execute well. Despite competition from overseas manufacturers and even domestic ones like  Polaris (PII) that imitate Harley's designs, the firm's wide moat is still intact despite slower growth prospects.

 Iron Mountain (IRM)
Morningstar Rating: 2 Stars
Economic moat: Wide
Business risk: Below Average
From analyst Marisa Thompson: Recently we met members of Iron Mountain's management team at an investor day, during which the firm discussed its five-year outlook. With a growing digital business adding another dimension to its existing physical storage solutions, the firm is making investments in infrastructure to gain more scale.

Iron Mountain's business model depends on recurring revenue from its storage business. Customers that outsource records management to the firm tend to become "sticky" due to the additional cost and burden of moving physical boxes and tape drives out of storage. Facing slumping internal growth, Iron Mountain made the decision a few years ago to reduce prices to drive higher volumes. The move likely will be accretive since the company is gaining scale in this business thanks to larger, better integrated facilities. At the same time, Iron Mountain is reorienting its salesforce to increase face-to-face contact with customers and provide more solutions to existing customers.

Iron Mountain is an expert at designing complex archiving systems, and we think the firm can become as competent with digital archiving as it is with physical archiving. The digital business drags on margins right now, but it has the greatest potential for improvement along with growth opportunities. The firm already has begun handling backup/recovery systems and e-mail archiving for Fortune 500 customers. Digital customers, such as those with physical storage needs, are "sticky" as well, thanks to the complexity of transferring bulk data and the thorny matter of maintaining an indexing system to comply with strict legal rules.

With a presence in more than 25 countries, international takeover opportunities are now fewer and further between because Iron Mountain has acquired most of the quality targets. Now that the acquisition phase is ending, the firm plans to rationalize its European real estate by selling mismatched facilities and building larger ones with more scale. Many European companies are still resistant to outsourcing document management, and cultural differences mean that it might take longer to win some contracts even if Iron Mountain can provide more cost-effective solutions. Remarkably, the physical business is still a major driver of growth, since businesses worldwide (especially in Asia, Latin America, and Eastern Europe) have not yet made the transition to a paperless workplace. Iron Mountain is balancing growth in its physical business with a firm footing in the future of digital archiving.