At Morningstar we think that buying high quality companies at a discount to intrinsic value is a sound two-pronged approach to investing.

We think that high quality companies – which we will define here as ones that benefit from a durable competitive advantage or Moat – are more likely to appreciate in value over time. This is because the Moat stops other companies from competing away their profits.

Meanwhile, we think that being patient and waiting for a bargain purchase price makes you less dependent on things going perfectly in the future. Because let’s face it, they rarely do. Benjamin Graham christened this as a “margin of safety”.

The following 11 shares – one in each sector – have been assigned a Wide or Narrow Moat rating by our analysts. Even better, they all command a four- or five-star Morningstar rating at the time of writing. This means our analysts think the shares offer a compelling discount to their opinion of Fair Value.

If these shares are aligned with your investment strategy, they could provide an opportunity to complement your Australian holdings with high quality global equity exposure. Please see this article by Mark LaMonica for a step-by-step guide to crafting your investment strategy.

Here are the shares by sector:

Akzo Nobel – Basic materials

  • Star rating: ★★★★★
  • Fair Value estimate: EUR 83
  • Uncertainty: Medium
  • Economic moat: Narrow

AkzoNobel is the third-largest company in the global paints and coatings industry, behind Sherwin-Williams and PPG Industries. The company's operations are divided into two segments: decorative paints and performance coatings.

Decorative paints are applied to external and internal buildings for cosmetic appeal and are essentially consumer products where brands, like Akzo’s Dulux, are important. By contrast, performance coatings are primarily functional products used in a variety of industrial end markets, including automotive, aerospace, oil and gas, marine, and packaging.

Our Akzo analyst Diana Radu believes Akzo’s decorative segment benefits from brand-related pricing power. Meanwhile, the performance coatings business benefits from product switching costs and deep relationships with customers that are generally less price sensitive. This is often because the qualities of Akzo’s protective coatings often save the business money elsewhere.

Many of Akzo’s end markets are cyclical and challenging market conditions have led AkzoNobel to scrap its 2023 strategic targets. The shares have fallen by around a quarter in the past year and now trade around 30% below Radu’s Fair Value estimate of EUR 83.

Universal Music Group – Communication services

  • Star rating: ★★★★★
  • Fair Value: EUR 31
  • Uncertainty: Medium
  • Economic moat: Wide

Universal Music is the largest of the three major record companies. Recorded music accounts for most of the firm’s revenue, with the segment housing more than a dozen record labels, including notable names like Interscope, Capital Music, Motown Records, and Def Jam.

With its impressive roster of both older and more modern artists, Morningstar’s Matthew Dolgin thinks Universal will be a primary beneficiary of growth throughout the music industry. The music industry’s evolution to the streaming business model turned out favorably for record companies. Recorded music now generates a continuing stream of revenue as opposed to the old model, where revenues were dominated by physical album sales, usually within a short time frame after an album’s release.

Dolgin believes the major record companies will remain integral to maximising recording artists’ earnings. The major record companies’ reputation, relationships and global reach are hard to replicate. This underpins his Wide Moat rating for Universal and should help them maintain relationships with current stars while continually signing the next generation of talent. Universal should also maintain control of legacy songs and recordings for many years.

Universal’s scale, resources, and current roster leave it in a strong position. Even better, shares currently trade at a 30% discount to Dolgin’s Fair Value estimate of EUR 31 per share.

Nike – Consumer cyclical

  • Star rating: ★★★★★
  • Fair Value: USD 124
  • Uncertainty: Medium
  • Economic moat: Wide

Nike shares have fallen by more than a third in the past year. The main catalyst for this fall was the weak outlook given in Nike’s June earnings report. However, the company has been out of favour for a while.

Economic conditions have been less than ideal, especially in China, which is expected to be a fast-growing market for sportswear. Meanwhile, investors are also concerned that Nike has become less innovative than new competitors like On and Hoka. So far, Nike’s increased focus on direct-to-consumer channels like e-commerce and Nike stores also hasn’t worked as well as hoped.

As he told said in this recent interview, Morningstar’s David Schwarz still believes that Nike is a wide moat company with big advantages in terms of visibility, product development, and distribution. Nike leads sportswear market share in most of the world’s major countries and is still very strong in basketball, running shoes and many other areas. All in all, it is the only sportswear company that Morningstar currently assign a Wide Moat rating.

By fiscal year 2026, Schwarz thinks that Nike can get back to sales growth as demand in its markets improves and new product releases drive sales. He also thinks that Nike has great opportunities in China and other developing economies such as Africa and India, where incomes are rising, populations are young, and the brand is already well known. Meanwhile, cost cuts should improve its profitability and the company’s direct-to-consumer efforts could reap further rewards on this front.

Nike’s recent share price of around USD 72 was significantly lower than Morningstar’s Fair Value estimate of USD 124. In a potential silver lining for Nike shareholders, its recent fall in price could allow the company to execute large share repurchases at lower prices than before. Nike management has historically used buybacks as the primary method of returning cash to shareholders.

British American Tobacco – Consumer defensive

  • Star rating: ★★★★★
  • Fair Value: GBX 3900 
  • Uncertainty: Medium
  • Economic moat: Wide

British American Tobacco is the world’s second largest tobacco company by volume, with cigarette sales to over 180 countries. With global cigarette consumption declining about 5% per year, BAT has invested in several next-generation products that can deliver nicotine with reduced risk.

Cigarettes remain the most important driver for BAT, constituting 81% of its 2023 revenue. In this category, the company holds several brands with high market shares, particularly in the US, its largest market for cigarettes. BAT maintains the second through fifth leading US brands by share, giving it about one third of the market in total behind Altria.

The US market is attractive, and our analyst Kristoffer Inton expects BAT can continue to increase prices to offset volume declines and drive robust free cash flow generation. This is partly because regulations, such as a ban on cigarette advertising, have virtually entrenched market leaders such as BAT and Altria. Taken alongside the addictive nature of tobacco and high levels of brand loyalty still apparent in the cigarette business, this underpins a Wide Moat rating.

At a price of around GBX 2745, BAT trades approximately 30% below our estimate of Fair Value. Inton thinks the market is overly discounting BAT relative to Philip Morris.

Enbridge – Energy

  • Star rating: ★★★★
  • Fair Value: USD 41
  • Uncertainty: Medium
  • Economic moat: Narrow

Enbridge is a midstream energy business. In other words, it transports oil and gas from one place to another. After its deal to acquire Dominion's utilities, Enbridge’s mix will be 50% liquids pipelines, 25% gas transmission, 22% gas distribution (where the utilities will reside), and 3% renewables.

Enbridge’s most important asset, the Mainline system, controls over 70% of Canada's takeaway capacity and is linked to highly complex US refineries that value heavy oil. Morningstar’s Stephen Ellis thinks this makes demand secure in the near to medium term despite an increase in US light oil production. He also notes that over 80% of Enbridge's EBITDA is protected against inflation.

Ellis awards Enbridge a Narrow Moat rating overall. He gives the liquids pipelines business a narrow moat as the pipeline projects are largely protected by long-term contracts in a region that is consistently short of pipeline capacity. He thinks the former Spectra assets, now part of Enbridge’s demand-driven gas transmissions business, have a wide moat, given their quality and irreplaceable nature. He also thinks Enbridge’s utility assets are narrow-moat businesses, given the local monopolies they enjoy.

Overall, Ellis thinks that Enbridge stands out among North American midstream operators with a utility like earnings profile. It currently trades around 9% below his Fair Value estimate of $57 per share.

PayPal – Financial services

  • Star rating: ★★★★★
  • Fair Value: USD 104
  • Uncertainty: High
  • Economic moat: Narrow

PayPal’s brand recognition and relationships with both businesses and consumers allowed it to gain a strong early foothold in online payments that has continued to this day.
Morningstar’s Brett Horn thinks PayPal will remain a preferred partner in the online world, given the relative convenience and security of its platform. But at the same time, its market position is not so strong that the company can dictate terms or gobble up increasing amounts of market share.

In the longer term, Horn sees a mix of competitive opportunities and threats that create a fairly wide range of outcomes for PayPal. These include traditional point-of-sale acquirers building out their online capabilities and services such as Apple Pay on the consumer side.

On the other hand, PayPal remains a preferred partner in the online space. Its unbranded payments business Braintree business is growing rapidly and PayPal could build a growing presence in in-person transactions. In balance, Horn thinks PayPal can hold its own but sees a broad range of outcomes. An additional attraction is Venmo, which is unlikely to be a major revenue driver anytime soon but could provide further upside in the long-term.

Horn thinks that PayPal’s Q2 results showed new CEO Alex Chriss making good progress in his attempts to shift the company toward a focus on profitable growth. He maintained his $104 fair value estimate and sees the shares as materially undervalued.

Zimmer Biomet – Healthcare

  • Star rating: ★★★★★
  • Fair Value: USD 175
  • Uncertainty: Medium
  • Economic moat: Wide

Debbie Wang sees Zimmer Biomet as the undisputed king of large joint reconstruction and expects aging baby boomers and improving technology for younger patients to fuel solid demand that should offset price declines.

Zimmer stumbled into a series of pitfalls in 2016-17, including integration issues, supply and inventory challenges, and quality concerns. Efforts to turn around the firm have been admirable, though the pandemic slowed down progress.

Wang’s Wide Moat rating for Zimmer stems from switching costs for surgeons trained on Zimmer devices and intangible assets such as sales relationships and intellectual property. On the latter point, changes in joint technology are evolutionary not revolutionary, meaning they rely heavily on IP established by earlier iterations of those devices. Wang also thinks that changes to US patent law favour larger incumbent firms like Zimmer over potential new upstarts.

Zimmer currently trades around 37% below Wang’s Fair Value estimate of $175 per share.

Melrose Industries – Industrials

  • Star rating: ★★★★★
  • Fair Value: GBX 870
  • Uncertainty: Medium
  • Economic moat: Wide

Melrose is a leading engine and structure components supplier through its GKN Aerospace business.

70% of GKN’s revenue comes from long-term contracts in which the company is the sole-source provider. In the engine segment, the company has a well-balanced portfolio and is a long-term partner with all of the major engine manufacturers, including Pratt & Whitney, GE Aerospace, Safran, and Rolls-Royce.

Despite the impact of the pandemic, air travel has shown resilience, particularly in the leisure sector and increased demand for narrow-body aircraft. By 2023, global flight hours had reached 2019 levels and Morningstar’s Loredana Muharremi expects them to grow an average of 8% during her forecast period.

Aerospace manufacturers have escalated production efforts and she expects the trend to continue in the long term to match soaring demand for aircraft and engines. This challenge was underscored by a deficit of around 2,500 aircraft due to the pandemic and Boeing’s setbacks with the 737 MAX model.

Muharremi ‘s Fair Value estimate of GBX 870 is supported by the expected growth in flight hours, a surge in defense expenditure in response to escalating global security concerns, and Melrose’s strategic shift in product mix toward higher-margin aftermarket revenue.

Crown Castle – Real estate

  • Star rating: ★★★★
  • Fair Value: USD 135
  • Uncertainty: Medium
  • Economic moat: Narrow

Crown Castle is provider of network infrastructure in the US, operating over 40,000 cellular towers. It is also a leading provider of third-party fiber networks and small cells assets.
Morningstar’s Samuel Siampaus maintains his narrow moat rating on Crown, stemming from efficient scale and switching costs present in its tower portfolio. Alternatively, he views its fiber business as no-moat, as it is less differentiated relative to its tower assets.

Siampaus expects that Crown’s tower business (which accounted for 68% of sales in 2023) will continue to benefit as carriers upgrade their networks to 5G and add capacity to meet growing data demand. He forecast Crown to grow its revenue per tower at an average of 4.5% per year through 2033.

Another positive in his book is the announcement that Crown are considering the sale of their fiber business and have reduced its capital spending outlook for the segment. Although lower capital spending could lead to weaker revenue growth, he views it as being beneficial to shareholders.

Crown Castle currently trades around 19% below Morningstar’s estimate of Fair Value.

Adyen – Technology

  • Star rating: ★★★★
  • Fair Value: EUR 1660
  • Uncertainty: High
  • Economic moat: Wide

Adyen solves the complex e-commerce payment needs of large and global sellers by combining the entire merchant acquiring and settlement value chain into a single platform. By doing so it can offer its clients local acquiring services globally, lower costs and the ability to scale worldwide more quickly.

Morningstar’s Niklas Kammer thinks that Adyen’s exposure to the fast-growing e-commerce space will continue to be the core growth driver. But Adyen is not a one-trick pony. While its strongest value proposition lies in e-commerce, but the lines between in-store, online, and mobile are blurring.

Adyen’s agnostic view of how a payment is initiated allows it to handle any payment via all channels over its single-code base payment infrastructure. This keeps capital expenses low, allows for faster development cycles and better shopper insights Adyen can offer its merchants.

Kammer’s EUR 1660 Fair Value estimate reflects his expectation of very strong growth rates. He expects acquiring volume to grow by an average of 21% over the next five years as Adyen boards more large merchants and expands with existing clients. Over his full 10-year forecast period, Kammer’s growth forecast declines to a still juicy average of 15%.

CenterPoint Energy – Utilities 

  • Star rating: ★★★★
  • Fair Value: USD 31
  • Uncertainty: Low
  • Economic moat: Narrow

CenterPoint Energy's regulated utilities have significant growth investment opportunities. Morningstar’s Andrew Bischof expects the company to invest over $22 billion over the next five years, supporting his expectation that management can achieve the high end of its 6% to 8% annual earnings growth target through 2030.

Management's 10-year, $44 billion-plus capital investment plan highlights its confidence in CenterPoint's natural gas business. The company aims to maintain its 60% electric/40% natural gas business mix. New investments will address customer growth, system reliability and resiliency, gas distribution safety and modernization, and renewable energy.

CenterPoint’s assets are located in areas with favourable population trends. Over half of its business in Texas, where legislation allows for shorter permitting timelines and there is 1%-2% annual customer growth. Minnesota and Indiana, which represent approximately 30% of rate base, have among the highest population growth rates in the Midwest.

Shareholders have benefited from management's portfolio rotation. CenterPoint exited its partial ownership stake in Enable Midstream Partners and used the proceeds to reduce leverage. CenterPoint also sold its natural gas distribution utilities in Oklahoma and Arkansas at very attractive prices.

Bischof thinks that reallocating capital to areas with more attractive growth and regulatory support is a positive for shareholders. These actions have shored up the company's balance sheet and provide an efficient source of funding for its capital investment plan.

 

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.