Economic moats are one of the keys to investing success, but it's not always easy to identify companies that have successfully carved a moat around their business to keep competitors at bay. 

To help, Morningstar developed its now well-established Economic Moat Rating system, building off the concept of company ‘moats’ widely popularised by US investment guru Warren Buffet.

Under the rating system, a company with competitive advantages expected to last more than 20 years is given a 'wide moat', and a 'narrow moat' signals a competitive advantage of at least 10 years.

But as the chart below shows, moats are not evenly spread across the ASX.

As of June 2023, no moat rankings are held by companies in the energy and capital goods sectors. Capital goods encompasses companies that manufacturer or distribute specialised machinery and equipment. 

Utilities stocks screen as the most moat-prevalent sector under Morningstar’s ASX coverage, with almost 90% of covered companies granted a narrow-moat ranking.

Commenting on why major energy retailers like Ampol (ALD) and Viva Energy (VEA) fail to qualify for a moat, Morningstar analyst Mark Taylor says competitive advantages are difficult to a acquire and maintain in the sector. 

“In the fuel supply and retailing industry, we think the two potential sources for a moat are cost advantage and efficient scale, but in our view, neither Viva or any other player is likely to achieve sufficiently maintainable competitive advantage from either aspect.”

Taylor notes that in the capital goods sector the “traditional engineering, procurement, and construction management space is competitive”, meaning even major groups like Worley (WOR) may find if difficult to fend off competitors to the degree needed to warrant a moat.

Rare moats hiding in competitive sectors


Looking at other largely no-moat sectors, a few standout moat ratings emerge. That said, investors should note that a moat-ranking is not the only factor used by Morningstar analyst to determine if a stock is a buy, hold or sell. 

A stock's current share price also plays a key role, as it helps determine whether the company is screening as 'undervalued', 'overvalued' or 'fairly valued', against Morningstar's assessed fair value.

1. The a2 Milk Company


Dairy producer, The a2 Milk Company (A2M)—which again made Morningstar’s Best Stock Ideas list this month—is the only ASX stock in the Food Beverage and Tobacco category to hold a moat rating.

Morningstar analyst Angus Hewitt says a2 Milk's narrow economic moat is based on its strong brand, which is continuing to drive growth despite higher prices than its competitors.

“These [market share] gains have come despite a2's generally premium pricing, suggesting consumers are willing to pay up for the brand,” he says.

“A2 Platinum generally runs about 50% higher in Australia versus other major players such as Nestle, Karicare, and Bellamy's. And in China, a2 is part of a growing consumer preference for premium, international brands instead of locally manufactured product, although the pricing premium is less pronounced versus major peers.”

Hewitt also notes that “risks on the horizon” have prevented a2 Milk obtaining a wide-moat rating, such as formidable competition in the Chinese infant formula market from international dairy conglomerates, and inconclusive scientific evidence surrounding the benefits of a2 Milk’s namesake products.

Shares in a2 Milk last traded at a 30% discount to Morningstar's fair value estimate of $7.20.

2. Wesfarmers


Another standout wide-moat ranking is held by ASX large-cap Wesfarmers (WES), which operates well-known brands like Bunnings and Kmart.

Wesfarmer’s holds the only wide-moat ranking among Morningstar covered retailing stocks, edging out narrow-moat automotive retailers Bapcor (BAP) and Eagers Automotive (APE). 

Analyst Johannes Faul says Wesfarmers’ wide-moat status is largely due to cost advantages from the significant scale, and the difficult-to-replicate store locations of its Bunnings business.

“Bunnings' moat is also sourced by the strength of its store network, an intangible asset, and is illustrated by the competing Masters hardware chain's failure to compete profitably,” he says.

Shares in Wesfarmers are trading at a 15% premium to Morningstar's fair value estimate of $42.00.

3. ASX Ltd


Domestic stock exchange operator ASX Ltd (ASX) also holds Morningstar's prized wide-moat ranking, indicating a competitive advantage of at least two decades.

While other well-established stocks in Morningstar’s diversified financials coverage have earned narrow-moat rankings—such as Block Inc (SQ2) and Macquarie Group (MQG)—ASX remains the only in the sector to hold a wide-moat.

Morningstar analyst Roy Van Keulen puts the stock’s wide-moat down to the network effects and intangibles in its listing, trading, clearing, technology and data businesses.

“ASX has an effective monopoly on equity listings in Australia with over 95% market share. Given this level of market share, we expect the financial ecosystem in Australia to continue consolidating around ASX.”

Keulen notes the ASX benefits from Australia's outsized natural resources sector, which is expected to continue delivering a constant flow of new listings.

“We believe this process will continue and even accelerate as the energy transition sparks demand for resources in which Australia holds world-leading positions, such as lithium, copper, rare earth minerals, iron ore, metallurgic coal, uranium, and natural gas.”

“We expect this will provide ASX with a constant stream of new listings and a long tail of recurring revenue from ongoing listing fees, secondary capital raisings, as well as trading, clearing, and settlement fees from these highly volatile materials and energy companies.”

Shares in ASX last traded at a 19% discount to Morningstar's fair value estimate of $75.00 apiece.

What makes a moat?


Morningstar has identified five company characteristics that could contribute to a moat:

  • Switching costs advantages, which keep customers from changing from one product to another.
  • The network effect, which occurs when the value of goods or services increase for both new and existing users as more people use that good or service.
  • Intangible assets—such as patents, government licenses, and brand identity that keep competitors at bay.
  • Cost advantages, meaning a company can produce goods or services at a lower cost, allowing them to undercut their competitors or achieve higher profitability.
  • Efficient scale in a given market, meaning that only a few companies are able to compete for similar resources, limiting rivalry.