5 Upgraded Stocks

Given the polar vortex that gripped much of the United States this week, it's safe to say that most of us hope the groundhog doesn't see his shadow this weekend.

For five stocks, however, spring came early: One new company that we brought under analyst coverage in January was awarded a narrow economic moat while four others experienced fair value estimate increases of more than 10%.

Here's a little bit about each company.

Komatsu

KMTUY

Economic Moat: Narrow

Moat Trend: Stable

Morningstar Rating (as of 1/31/19): 3 stars

Our analysts began covering Komatsu, rewarding it with a narrow economic moat rating. Based in Tokyo, Komatsu is the second-largest construction equipment manufacturer in the world by revenue. We think the company's construction, mining, and utility equipment business--which accounts for around 90% of its revenue and operating income--possesses a narrow moat, argues analyst Ken Foong. That moat is derived from its intangible assets: superior product quality, consistent research and development spending, a strong dealer and service network, and captive finance capability. Those intangible assets have helped Komatsu solidify its leading position in the construction machinery space, he adds.

Shares are fairly valued as of this writing.

"We see modest upside, underpinned by its growth potential following the acquisition of Joy Global in 2017 and steady demand growth from China, Asia (excluding China and Japan), Europe, Oceania, and North America," says Foong. "In the long term, we believe Komatsu's superior product quality, brand name, continuous investments in research and development, focus on lowering the total cost of ownership for its machinery, extensive dealership network, and after-sales service will ensure its competitiveness and support its growth."

Ball Corp

BLL

Economic Moat: Narrow

Moat Trend: Stable

Morningstar Rating (as of 1/31/19): 2 stars

We upped our fair value estimate of narrow-moat Ball by 11% (or $4.50). The world's largest metal can manufacturer posted a solid fourth quarter, thanks to decent results in its beverage-can operations (which represent about 85% of revenue) and exceptionally strong sales growth in its smaller aerospace business.

"With Ball more successfully converting aerospace backlogs into sales, we've meaningfully increased our growth assumptions for the segment over the coming five years to average 7%, with 15% growth next year," explains analyst Charles Gross. "As a result, we're increasing our fair value estimate for Ball to $45 per share from $40.50."

Beverage-can production is a low-growth industry, but one with favorable competitive dynamics for incumbents, explains Gross. Consolidation of facilities in Europe and North American should keep operating rates and margins high in the coming years, too. With the aerospace business, recent investments have proved fruitful: New hiring initiatives and facility expansions are boosting top- and bottom-line growth, adds Gross.

Shares are currently rich, trading 29% above our fair value estimate.

Netflix

NFLX

Economic Moat: Narrow

Moat Trend: Stable

Morningstar Rating (as of 1/31/19): 1 star

We raised our fair value estimate of Netflix by $15 (representing a 12% boost). The narrow-moat streaming service finished 2018 with stronger than expected international subscriber growth. However, the free cash flow loss for the quarter was a record $1.3 billion, raising the loss for the year to just over $3 billion, or 19% of total revenue, says senior analyst Neil Macker.

Macker notes that the fair value increase is "primarily from incorporating faster international customer growth. We believe the increased U.S. pricing, announced prior to earnings, will be largely offset by lower U.S. net customer additions in the near term and smaller subsequent price increases than the firm would have been able to implement had it taken a lesser increase this year."

Macker adds that Netflix will face stronger competition both here and abroad, leading to ongoing increases in content and marketing spending that will limit margin expansion. Shares are highly overvalued, in our opinion, trading at a 151% premium to our fair value estimate as of this writing.

"In short, we don't believe Netflix's current share price considers the potential changes to consumer behavior that a combination of higher prices and increased competition could create, to the detriment of Netflix's business," he concludes.

Xilinx

XLNX

Economic Moat: Narrow

Moat Trend: Stable

Morningstar Rating (as of 1/31/19): 1 star

We raised our fair value estimate of Xilinx by 14% in January to $80 per share from $70. Along with Intel INTC, Xilinx dominates the field-programmable gate array (FPGA) market, and it posted stellar quarterly results across its end markets. Communications revenue grew 41% thanks to 5G strength as well as some LTE upgrades, says senior analyst Abhinav Davuluri. Industrial, aerospace, and defense rose 17% due to multiple defense and space programs; automotive, broadcast, and consumer grew 20%; and data center grew 14% due to the adoption of FPGAs in computing, storage, and networking segments.

"Based on its guidance, Xilinx is poised to surpass the $3 billion threshold for fiscal 2019, which would be a record revenue level," notes Davuluri. "[CEO Victor] Peng’s strategy of driving double-digit top-line growth via an uptick in research and development is executing very well."

Shares are trading at a 40% premium to our fair value estimate as of this writing.

"We'd recommend prospective investors seek a wider margin of safety, given the recent volatility in the semiconductor and broader markets," he adds. "Specific to Xilinx, there is a risk that the escalating tensions between the U.S. and China will result in a ban of sales to the latter's key telecom giant, Huawei."

Xylem

XYL

Economic Moat: Narrow

Moat Trend: Positive

Morningstar Rating (as of 1/31/19): 3 stars

We raised our fair value estimate on Xylem to $72 per share from $64--a 12% uptick--on the basis of more optimistic revenue growth, operating margin, and working capital efficiency assumptions, says analyst Krzysztof Smalec.

One of the leading water technology companies in the world, Xylem's portfolio spans a wide range of equipment and solutions for the water industry, including the transport, treatment, testing, and efficient use of water for public utilities as well as industrial, commercial, and residential customers.

"We project 6.5% annual revenue growth from 2019 through 2022, fueled by almost 8% growth in the measurement and control solutions segment," he explains. "We project a roughly 300-basis-point operating margin expansion, from approximately 14.5% pro forma 2018 numbers to around 17.5% by 2022. We expect this improvement to be driven by business simplification, head count and footprint rationalization, procurement savings, and lean initiatives."

Our forecast assumes increased working capital efficiency, partly driven by the Sensus acquisition, says Smalec. More efficient inventory management should improve free cash flow conversion, too.

Shares are about fairly valued today according to our metrics.