"Change is inevitable. Change is constant."
So said British statesman and novelist Benjamin Disraeli. He had a point. Kids grow up. Summer eventually gives way to fall. And if left long enough in your refrigerator, last night's dinner will change, too.
The same can be said for companies--they change. Cash-burning startups, if managed properly, generate profits at some point. Some build significant competitive advantages. More-mature and already profitable companies, meanwhile, face new competitors. Some adapt and innovate; others stagnate and cede market share.
The Morningstar Economic Moat Rating for a given company--whether that rating is none, narrow, or wide--can change, too, based on whether a company's competitive advantages (or lack thereof) shift.
This month, we adjusted the economic moat ratings on three companies--two received upgrades while one was downgraded. Companies that have enjoyed moat upgrades aren't automatic buys, nor are those with moat downgrades sell candidates. It all depends on where the stocks are trading relative to our fair value estimate. And as of this writing, none of the stocks here is trading in buying range.
Here's what our analysts had to say about each moat rating change.
Upgraded Morningstar Economic Moat Rating to wide from narrow Morningstar Rating (as of June 14, 2021): ★★★
"We're raising our economic moat rating for Chipotle to wide from narrow, as the company's strong unit economics, same-store sales, and recent operational enhancements leave us convinced that excess returns (and the strikingly efficient assembly-line burritos that underpin them) look poised to stay. Despite extending our horizon for excess returns, we maintain our fair value estimate at $1,200 per share, still about 14% behind current market prices, as we incorporate our projected 26% federal tax rate into our model. We would be ready buyers on a pullback, however, with new-format stores, increased capacity from second-make lines, sticky digital sales, and compelling 35% cash-on-cash returns laying the groundwork for double-digit top-line growth (16%) and high-single-digit comparable sales growth (7%) through 2025.
"Chipotle has, in our view, left its food safety issues behind, with a symbolic Department of Justice agreement in April 2020 likely closing the door on the unfortunate chapter in an otherwise stratospheric rise for the fast-casual mainstay. The brand has astutely navigated a dynamic industry environment, with heavy investments in digital ordering and loyalty underpinning 7% system sales growth in 2020, even as the limited service industry fell nearly 3% in aggregate. Heady trailing 10-year comparable sales growth of 6% corroborates this view, handily outpacing the limited-service industry (1.3%) and our fast-casual competitive set (1.7%) over the same period, per our calculations and Euromonitor data. With comparable sales driven by price increases and traffic growth, we view this as an appropriate indicator of brand strength, further attested to by the firm's structurally lower marketing expenditure (2.5%-3.5%) than fast-food peers (4%-6%).
"We're encouraged by Chipotle's rapid recovery since its food-safety scare, with strong loyalty adoption, Chipotlanes, and sticky digital volumes (50% of first-quarter sales) laying the foundation for sustained outperformance."
--Sean Dunlop, analyst
Downgraded Morningstar Economic Moat Rating to narrow from wide Morningstar Rating (as of June 14, 2021): ★★★
"We are downgrading Enbridge's moat to narrow from wide, primarily because of concerns regarding the durability of midstream returns earned from serving Canadian oil and gas oil sands efforts. Our narrow moat is based on an efficient-scale moat source. While we remain very confident in demand for Canadian oil (an approximate 1.8% compound annual growth rate through 2030) and gas (9% CAGR over the same time frame) in the near to medium terms, we are far more uncertain around long-term demand in the latter stages of our forecast owing to the high carbon emissions intensity associated with the full cycle of oil sands production, which is a primary source for Enbridge's assets. Oil sands' carbon intensity is among the highest of all the basins we cover, and it is disproportionately exposed to threats if countries and governments continue to seek ways to reduce greenhouse gas emissions. We expect material stakeholder challenges from legal, regulatory (Enbridge already pays carbon taxes, for instance), and community perspectives for any new major Enbridge project, and likely new oil sands projects from producers, challenging the investment case for new pipes and boosting costs for existing assets. Beyond stakeholder issues, we believe refineries that run heavy crude slates that require Canadian heavy are increasingly looking to renewable diesel (produced from food waste), raising significant questions around the sustainability of long-term demand. Finally, while the nascent hydrogen and other renewable opportunities offer ways for Enbridge to manage the energy transition, we believe they could become narrow-moat businesses, at best, further reducing our confidence in an overall wide moat rating.
"Our fair value estimate for Enbridge is $44 (CAD 53) per share. Our fair value estimate has declined from our prior $46 (CAD 59) estimate owing to the shorter period of excess returns with the moat downgrade to narrow from wide."
--Stephen Ellis, strategist
Upgraded Morningstar Economic Moat Rating to wide from narrow Morningstar Rating (as of June 14, 2021): ★★
"After taking a fresh look at our thesis on Nvidia, we are raising our moat rating to wide from narrow thanks to intangible assets related to the design of graphics processing units, or GPUs. Nvidia has focused on expanding opportunities for its GPU technology beyond PCs, which we think are making the firm's intellectual property around GPU design increasingly valuable. Collectively, these applications represent multiple avenues for Nvidia to advance its intellectual property and remain at the cutting edge for GPU technology and give us confidence in the long-term sustainability of the firm's competitive advantages.
"We are raising our probability-weighted fair value estimate to $550 per share from $515 as a result of the moat rating change. Nvidia is in the process of acquiring Arm Holdings, and if the deal closes, our fair value would increase to $600 per share. If the deal does not close, we assign Nvidia a fair value estimate of $500 per share, up from $465, as we anticipate excess returns over a longer period of time commensurate with a wide moat rating. Overall, our probability-weighted fair value estimate assigns a 50% probability of closing due to potential regulatory scrutiny and Arm customer pushback. Nvidia is paying a high multiple for Arm's earnings, but given the GPU leader's share price is trading at a significant premium to our updated stand-alone $500 fair value estimate, we like that Nvidia is using its rich shares to fund a large portion of the deal.
"Nvidia is the leader in discrete graphics. We think the market has significant barriers to entry in the form of advanced intellectual property. To stay at the cutting edge of GPU technology, Nvidia has a large research and development budget compared with Advanced Micro Devices AMD and smaller GPU suppliers, which allows it to continually innovate and fuel a virtuous cycle for its high-margin chips."
--Abhinav Davuluri, strategist