Finding quality stocks trading at a cheap price can be a challenging and time-consuming task. You not only need to identify whether a company has a tangible edge over its peers. You also need to assess whether a stock is over- or under-valued.

The Global Best Ideas list (available for Morningstar Investor subscribers) is compiled by Morningstar’s equity analysts every month. To earn a spot on the list, these stocks have high analyst conviction in their future prospects and are trading at a price significantly below what our analysts calculate them to be worth.

Buying stocks when they are undervalued gives investor’s a higher margin of safety, therefore reducing the risk of an uncertain future.

Additionally, analysts consider the stock’s moat rating. This rating is an indication of the analyst’s expectations for the company to maintain a sustainable competitive advantage. A wide moat rating is awarded to companies that are expected to maintain and grow their earnings for at least the next 20 years, a narrow moat for the next 10 years.

Brian Han, Director of Equity Research, says of the list “These Best Ideas are sourced from all main sectors of the market, to provide a diversity of names across the spectrum. The last thing investors want is a Best Ideas list chock-full of cheap mining stocks when commodity prices tank, or a litany of oversold retail stocks when consumer sentiment slumps.”

The list of Australian shares on the July list did not change from June. Instead of highlighting new additions we identified three members of the list that have dividend yields above 5% that may interest income investors.

Dexus (ASX: DXS)

Our first pick is local. Dexus is a major Australian property owner, developer, and manager. It owns a large, high-grade office portfolio and a smaller industrial portfolio in Australia. It also manages properties on behalf of third-party investors.

The group's office portfolio is currently earning higher-than-market rents, which implies earnings downside as leases expire and tenants negotiate lower rents. However, its average office lease length is 4.5 years, which offers a fair bit of time for the office market to recover.

We think that's likely, given city centers in Sydney and Melbourne are getting busier. We expect even more inner urban activity as major public transport projects are completed over the next few years, including Sydney Metro, Melbourne Metro Tunnel, and Brisbane Cross River rail, all of which should benefit Dexus' locations.

Meanwhile, Dexus' industrial tenants are paying below-market rates and Dexus is able to implement large price increases when leases expire. We also expect the group's funds management earnings to grow. Dexus trades well below its net tangible assets of $10.04 per security, and we estimate it trades on a fiscal 2024 distribution yield of 7.1%, which we believe offers a valuation cushion and compensation for investors while they wait for recovery.

Dexus’ funds management business has a moat from switching costs. The group’s wholesale funds management clients face potential notice periods, exit penalties, transaction costs, and tax effects if they switch out of Dexus vehicles.

It takes time to add CBD office supply in Sydney and Melbourne, due to a combination of planning hurdles, lack of suitable sites, geographical impediments, and a tightly controlled market. Efficient scale deters rational new competitors from entering the market unless they are confident the new supply will not undermine returns for landlords over the long term.

Realty Income (NYSE: O)

We head to the US for our next pick. Realty Income owns roughly 15,400 properties, most of which are freestanding, single-tenant, triple-net-leased retail properties. Its properties are located in 49 states and Puerto Rico and are leased to 250 tenants from 47 industries. Recent acquisitions have added industrial, gaming, office, manufacturing, and distribution properties, which make up roughly 20% of revenue.

Realty Income currently trades at a material discount to our $76 fair value estimate. We think the shares have traded down since August 2022 because of rising interest rates. In our analysis of stock performance and interest-rate movements, we have found that Realty Income is the most sensitive REIT that we cover, with its stock showing the greatest negative correlation with interest rates.

It has positioned itself as ‘The Monthly Dividend Company’, so many investors are attracted to the name when interest rates are low. However, those investors may rotate out of the name and into risk-free Treasuries when interest rates rise. However, the current yield of 5.36% is attractive on a historical basis.

Additionally, since the company sets annual rent escalators relatively low, it relies on executing billions in acquisitions each year to fuel overall growth. Rising interest rates have reduced the spread between the company's acquisition cap rates and the weighted average cost of capital used to fund those acquisitions, thus potentially reducing growth.

However, Realty Income has actually ramped up the volume of acquisitions over the past several years and still acquires at a positive spread over its cost of capital. It executed $9.5 billion in acquisitions at an average cap rate of 7.1% in 2023, well above the average interest rate of approximately 5% on the debt the company issued to fund those deals.

The company's $9.3 billion acquisition of Spirit Realty, which closed in January 2024, should also be accretive to shareholder value. We anticipate that management will be able to continue to find deals that increase funds from operations, thereby supporting continued dividend growth for shareholders. We think the selloff caused by rising interest rates presents investors with an attractive entry point, particularly if the Federal Reserve announces any rate cuts in 2024.

Hasbro (NYSE: HAS)

We stay in the US for our last pick. Hasbro is a branded play company providing children and families around the world with entertainment offerings based on a world-class brand portfolio. From toys and games to television programming, motion pictures, and a licensing program, Hasbro reaches customers by leveraging its well-known brands such as Transformers, Nerf, and Magic: The Gathering. Ownership stakes in Discovery Family, which offers programming around Hasbro brands, and production capabilities has helped bolster Hasbro's multichannel presence.

Hasbro's shares have struggled to keep pace over the past 12 months, with an 8% decline (versus around a 22% increase in the Morningstar Global Markets Index), rendering shares significantly undervalued relative to our $84 fair value estimate.

We think weak share performance is reflective of a business in transition that faced idiosyncratic risks, such as slower entertainment growth from the 2023 Writers Guild of America strike and the overhang from the sale of the majority of the EOne production business (closed December 2023).

With Hasbro now largely liberated from the low-margin EOne entertainment business, we expect significant lift from an improved revenue mix, with the high-margin Wizards of the Coast and digital segment set to represent around 34% of sales in 2024 (from 29% in 2023).

Furthermore, with a higher focus on core competencies, we think Hasbro is set to benefit from more concentrated innovation and a leaner operating model?bolstered by the outlicensing of lower-productivity brands to partners, which should help free up working capital. Additionally, as a result of a stringent focus on expenses, Hasbro is set to reduce gross costs by $750 million by the end of 2025, supporting profit growth.

While the company is targeting a 20% operating margin by 2027, we think the firm has the potential to reach 20% by 2025, with long-term operating margin stabilizing around 23%-24%. As such, we think the opportunity for Hasbro to outperform expectations is possible given the renewed focus on product innovation, cost management, and lean operating profile. The shares are currently yielding 4.68%.

We assign a narrow economic moat to Hasbro stemming from an intangible asset edge that has arisen from strong brands that have resonated with consumers over an extended period, bolstered by a topnotch ability to market products successfully, and an entrenched distribution network. As evidence, the firm boasts solid market share and pricing power, as well as the ability to win licensing contracts, combined with symbiotic wholesaler/retailer relationships.

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