3 ASX no-moat shares that are significantly overvalued
Investors are too optimistic about the prospects for these three ASX listed companies.
There are lots of opinions about investments that people should buy. We hear these opinions in the media, from investment professionals and from our friends and families. Some of us have even had the pleasure of receiving unsolicited opinions from complete strangers.
Investors are always on the lookout for a strong company at a great price, but it is also worth noting which companies are trading a significant premium to their fair value estimate.
To collate the list, all companies in Morningstar’s ASX coverage universe are ranked by comparing their recent trading levels against Morningstar’s assessed fair value estimate for the given stock.
Shares trading at a significant premium to Morningstar’s fair value estimate are considered “overvalued”, while shares are trading well below their fair value estimate are considered “undervalued”.
This ratio—along with a company’s uncertainty rating—helps determine Morningstar’s overall star rating for a stock. The star rating provides a margin of safety for investors.
We have added an additional piece of criteria by finding shares that have not been granted a Wide or Narrow Morningstar Moat Rating from our analysts.
Companies without moats means our analysts do not believe they have a sustainable competitive advantage. Over time a company without a sustainable competitive advantage will be unable to protect their margins and returns on invested capital to competitors. They may still grow revenue by won’t the extra returns on investments that make for successful investments over time.
By highlighting the overvalued stocks on this list, we hope to identify companies that could represent a significant price risk for investors at their current trading levels.
All data is current as of December 12, 2023.
Fortescue Ltd (ASX: FMG)
Fortescue is an Australia-based iron ore miner. It has grown from obscurity start of 2008 to become the world's fourth-largest producer. Growth was fueled by debt, now repaid. Expansion from 55 million metric tons in fiscal 2012 to about 190 million metric tons in 2023 means Fortescue supplies nearly 10% of global seaborne iron ore. Further expansion above 200 million metric tons is likely once it completes construction of its 22 million metric tons Iron Bridge magnetite mine. Fortescue is currently trading at a 62% premium to our fair value estimate of $16.
Margins are well below industry leaders BHP and Rio Tinto, and some way behind Vale, meaning Fortescue sits in the highest half of the cost curve. Lower margins primarily result from price discounts from selling a lower-grade (57% to 58% iron) product compared with the 62% iron ore benchmark.
The lower grade is effectively a cost for customers through a greater proportion of waste to transport and process, additional energy/coal per unit of steel and lower blast furnace productivity. This results in a lower realized price versus the benchmark. In the 10 years ended June 2023, the company realized an approximate 23% discount versus the 62% benchmark.
We now assume iron ore averages about USD 105 per metric ton from 2023 to 2025 based on the futures curve compared to a current price of USD 135. Our assumed midcycle iron ore price remains roughly USD 60 per metric ton from 2027, based on our estimate of the marginal cost of production.
Our assumed midcycle price acknowledges the rising costs across the industry due to inflation, along with supply discipline from the iron ore majors and mine depletion likely meaning the marginal cost is determined by smaller, higher-cost mines.
It also considers the recovery of Vale’s output and Simandou starting production. We forecast around 2.1 billion metric tons of global steel production in 2026, with production from China around half of this as its economy moves away from one reliant on fixed-asset investment to a more consumption-based economy, and as its scrap-based production increases.
We assign Fortescue a no-moat rating. The iron ore produced by its mines generally has less iron content than the 62% iron ore benchmark while also having higher percentages of impurities such as sulphur, alumina and phosphorous. As a result, Fortescue’s iron ore is lower quality than that produced by its major competitors such as BHP, Rio Tinto and Vale. This competitive disadvantage results in its iron ore tending to sell at a material discount to the 62% benchmark price, with the average discount over the 10 years to fiscal 2023 being about 23%.
As a commodity producer, Fortescue is a price-taker and needs low-cost mines with long lives and a low installed capital base to support the longer-term excess returns needed to justify an economic moat.
Super Retail Group (ASX: SUL)
Super Retail operates in Australia and New Zealand selling auto parts, sporting goods, and outdoor leisure equipment. The group generates revenue of about $3.5 billion. There are generally two to four larger players in each category in which the firm operates, with Super Retail the market leader in all three categories. The shares are currently trading at a 42% premium to our fair value estimate of $10.50.
There are challenging structural shifts facing the firm in the near term. With the recent arrival of new international retailers, both traditional and online, we expect competition to remain intense across all the group’s segments, resulting in price-cutting, pressure on profit margins, and greater investment needs in digital channels and in-store service.
Competitive threats in the auto-parts segment are less intense than in sporting goods, which we view as the most exposed. We expect operating margins to decline, mainly driven by prices deflating, as Rebel Sport essentially gives up profitability to maintain market share at the current level.
Although facing less new competition from the brick-and-mortar channel, Amazon also competes in the Australian auto-parts market, making material expansion of operating margins or market share gains unlikely in the auto-parts segment. The benefit from in-store services that differentiates Supercheap Auto from online pure plays is limited, and easily replicated by incumbent auto-parts retailers Autobarn and Repco.
Super Retail Group lacks an economic moat. The firm operates across three segments, namely auto, sporting goods, and outdoor. These segments account for about 50%, 40%, and 10% of operating profits, respectively.
The group is the market leader in all three segments in Australia, with about 30% market share in auto part retailing, 25% in outdoor, and 25% in sporting goods. However, we believe the formidable competition from existing and new competitors across the brick-and-mortar and online channels, such as Amazon, traditional international retailers, as well as manufacturers themselves, will constrain operating margins as the firm competes on prices to maintain market share.
The large store networks facilitate click-and-collect distribution, and increasing private-label sales are a competitive advantage, but not enough to consistently generate returns above the group’s cost of capital.
ALS Limited (ASX: ALQ)
Founded in the 1880s and listing on the ASX in 1952, ALS operates three divisions: commodities, life sciences, and industrial. ALS commodities traditionally generated the majority of underlying earnings, providing geochemistry, metallurgy, inspection and mine site services for the global mining industry. Expansion into environmental, pharmaceutical and food testing areas and commodity price weakness have lessened earnings exposure to commodities.
Over the past 5 years ALS has appreciated close to 75% but that has led to the shares trading at a 47% premium to our fair value estimate of $8.60. We believe that the market has gotten ahead of itself based on recent optimism after a stronger than expected first half. A decline in minerals earnings is the most likely catalyst for share price retracement.
During the mining boom, the minerals division was the growth engine. Earnings before interest and taxes (“EBIT”) almost doubled within two years, and minerals still accounts for just under half of group EBIT.
The minerals division provides services across the exploration, expansion, and production stages. These include sample preparation, quantity and quality analysis, grading and process plant control/optimization, and preshipment inspection across a vast range of minerals and commodities such as gold, silver, platinum, iron ore, nickel, bauxite, and uranium. Earnings are heavily tied to exploration-type projects. ALS charges market-leading prices for superior service, reputation, and timeliness.
ALS is leveraged to overall global economic health, the same as other contract service providers. Commodity-tied earnings remain exposed to China, the ability of junior miners to raise funds, flow-on impacts from economic instability, commodity prices, rising costs of projects, and exploration budgets. Any gains by the Australian dollar could be a drag on earnings, eroding benefits from offshore margin improvements.
ALS does not have an economic moat. While it has a strong reputation, technical capabilities, global network, and established relationships with global clients, none of those attributes are sufficient to underpin an economic moat.
Capital outlays in establishing a global network of operations and laboratories appeared modest during the China-driven resources boom. But a subsequent retreat in commodities prices means ALS is barely earning its cost of capital on an adjusted basis, and if goodwill is included, returns do not currently meet the cost of capital.