Looking Abroad for Quality Bargains

Morningstar's Wide Moat Focus strategy targets the cheapest, highest-quality stocks in our coverage area. But sometimes "cheap" is relative concept. True, the strategy targets the most undervalued stocks in its universe based on price/fair value, but that universe--the Morningstar US Market Index--has gained more than 16% per year for the trailing five-year period.

Meanwhile, the MSCI ACWI Ex USA has returned only half of that amount. Some of the relative underperformance of foreign stocks over the past few years is due to currency translation effects; in other words, the stocks have performed well in their own markets, but when translated to U.S. dollars the strength of the greenback relative to the other currencies has the effect of muting gains, sometimes significantly so. But the five-year performance between the local-currency-denominated index and the USD-denominated index are very close, gaining 8.2% and 7.3% per year through Sept. 26, respectively. This argues that foreign markets may not be as overvalued as the U.S. market, and there may be some bargains to be found for patient investors.

For bargain-hunters who want to look abroad, the Morningstar Global ex-US Moat Focus Index allows you to harness the moat strategy to find high-quality bargains in developed and emerging markets. Like the Wide Moat Focus, the Global ex-US Moat Focus is pretty straightforward. First, we look at the Morningstar Global Markets ex-US Index, which is a broad global market index representing 97% of developed (ex-US) and emerging-markets market capitalization. From there, we rank by lowest price/fair value to find the 50 cheapest wide- and narrow-moat stocks (meaning we think they have advantages that will fend off competitors for at least a decade). These 50 stocks represent the most compelling values among the global moat universe, according to Morningstar analysts.

It should be noted that the Global ex-US Moat Focus index, which is intended as an investment strategy and is licensed for investable products, invests in securities in their local currencies, on their local exchanges. However, individuals can also use it as a watch list or a place to find investment ideas. We searched for undervalued stocks in the index that are available to U.S. investors through American Depositary Receipts (which allows a certain number of shares of a non-U.S. company to be traded on a U.S. exchange). The following six stocks are selling at compelling valuations.

Cameco

CCJ

Moat: Narrow Fair Value Uncertainty: High Price/Fair Value: 0.48

Uranium prices currently languish around $26 per pound, down about 24% from the start of the year.

this is a function of current oversupply, where production exceeds demand. But Wang expects market balance to turn into a deficit by 2021, as Japanese restarts and new reactor builds in China, South Korea, India, and Russia outpace a weak supply growth pipeline. Cameco is uniquely positioned to profit when the market dynamics shift, as it owns several of the world's highest-grade uranium deposits and is one of the lower-cost producers. Wang believes Cameco shares are meaningfully undervalued at current prices.

Sanofi SA

SNY

Moat: Wide Fair Value Uncertainty: Medium Price/Fair Value: 0.71

Patents, economies of scale, and a powerful distribution network support Sanofi's wide moat, says Morningstar sector director Damien Conover. Sanofi's patent-protected drugs carry strong pricing power, which enables the firm to generate returns on invested capital in excess of its cost of capital. Though increasing branded competition and a deteriorating pricing environment will likely lead to sales declines over the long term for the company's largest drug, long-acting insulin drug Lantus, Sanofi's vaccines, consumer products, and animal health treatments should help offset this weakness by continuing to post growth as these products are less susceptible to patent losses. In addition, Sanofi is launching cholesterol-lowering drug Praluent, which holds "major blockbuster potential," says Conover.

Lloyds Banking Group PLC

LYG

Moat: Narrow Fair Value Uncertainty: Very High Price/Fair Value: 0.71

Lloyds has done a lot to right the ship in recent years. It nearly destroyed itself in 2008 with its notorious acquisition of HBOS, and the U.K. government ended up with 43.5% of the combined group. Now, after years of bailouts and setbacks, the bank has essentially righted itself, and the government has largely sold down its stake, said Morningstar sector director Stephen Ellis. With noncore assets and government ownership now down to minimal levels, Lloyds is re-emerging as one of the sturdiest banks in Europe, says Ellis--it's a strong, conservative, and impressively profitable retail-focused institution. Now that the bank has substantially completed its turnaround, Ellis thinks its moaty retail and commercial bank will be the biggest driver of results going forward, rather than legacy issues.

Roche Holding AG

RHHBY

Moat: Wide Fair Value Uncertainty: Low Price/Fair Value: 0.75

Strategist Karen Andersen thinks Roche's combination of a strong drug portfolio and industry-leading diagnostics results in sustainable competitive advantages. In the pharmaceutical segment, Andersen points out that blockbuster cancer biologics acquired with Genentech--including Avastin, Rituxan, and Herceptin--continue to grow quickly as they gain market share in approved indications, and they have also gained approval in new indications as well as in emerging-markets. Roche's diagnostics business is also industry-leading: With a 20% share of the global in vitro diagnostics market, Roche holds the number-one spot in this industry. The firm's wide moat owes to its status as the leader in oncology therapeutics (30% market share) as well as in vitro diagnostics (20% share); further, Andersen points out that Roche "has a promising strategy of combining its expertise in both areas to generate a growing personalized medicine pipeline."

Teva Pharmaceutical

TEVA

Moat: Narrow Fair Value Uncertainty: Medium Price/Fair Value: 0.75

Senior equity analyst Michael Woodhouse concedes that slowing generic market growth and recent generic competition on oral multiple sclerosis drug Copaxone create big hurdles for Teva. However, he notes, Teva still has many competitive advantages that should help uphold earnings. The company's large scale and vertically integrated generic drug manufacturing business, combined with intellectual property protection and a modest pipeline in the specialty drug segment, lead us to award it a narrow economic moat rating. Though the generics market remains fairly fragmented, with relatively lower barriers to entry, a select few firms control the lion's share of worldwide generics production. Teva is one of those firms; it has the necessary scale and raw material inputs to maintain low-cost operations in the relatively commodified generics market, Woodhouse says.

Carnival PLC

CUK

Moat: Narrow Fair Value Uncertainty: High Price/Fair Value: 0.84

Carnival is the largest company in the cruise industry, which allows it to reach a diverse group of consumers in a lightly penetrated vacation segment, says Morningstar equity analyst Jaime Katz. In Katz's opinion, Carnival's efficient scale, the lowest unit costs in the industry, and intangible brand assets provide the company with a narrow economic moat. Though Katz expects Americans' demand for European itineraries to remain soft in the second and third quarters next year owing to uncertainty surrounding Brexit as well as numerous terrorist incidents earlier in 2016, she thinks

. Katz views the shares as undervalued at current levels, trading in 4-star territory.

All price/fair value data as of Sept. 27, 2016.

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