Ticker Take: Morningstar Stock Analyst Blog

Buffett and Gates Visit Oil Sands

2008-08-20T20:32:17Z

The Calgary Herald reported that Warren Buffett and Bill Gates visited the oil sands of northern Alberta on Monday, which will undoubtedly draw more attention to the vast resources of the region. The Herald's source said the visit was both "to satisfy 'their own curiosity' but also 'with investment in mind'."

The wealthy pair toured Canadian Natural Resources' CNQ Horizon project, which we were fortunate enough to visit ourselves back in June. Despite hiccups along the way, this massive undertaking is finally ready to bear fruit. We've long been impressed with the way CNQ runs its business, which is why we were so glad to have the company speak at our annual stocks forum in April. Its long-term, disciplined approach truly puts shareholders first.

While we expect the availability and productivity of labor to be among several major challenges facing new projects over the next few years, the oil sands truly are a huge, well-defined resource. Low reinvestment risk eliminates the access-to-resource issue facing global operators, who have fewer and fewer sandboxes to play in. And as the reliability of supply from Mexico and Venezuela becomes even more uncertain, American refineries may come to rely more heavily on Canadian crude, despite ongoing environmental debate.

CNQ has hit 5-star territory frequently over the past year. Last week, we highlighted the undervaluation of its stock and a few other Canadian energy stocks in a Strategist article.

Among our other 5-star names in Canadian energy, EnCana ECA and Nexen NXY also have oil sands exposure. The impatient market can sometimes overlook the long-term value of these big resources, which is one reason EnCana will be splitting into a natural gas company and an integrated oil company.

Please visit our individual Premium company reports for more info. If you’re not a Premium Member, you can still access our reports by taking a free trial.

Welcome to Ticker Take

2008-06-10T20:47:35Z

Welcome to Morningstar's Ticker Take.

We have a specific view of stock investing here at Morningstar. We think investors should purchase shares of wide moat companies at attractive prices and hold for the long-term. This is an excellent approach that will lead to solid returns, but there are many paths to investing nirvana.

One of the goals of Ticker Take will be to highlight those other paths. Don't expect, however, to see stock charts filled with chaotic lines and a discussion of technical analysis. We're still going to stick to things that actually work.

To that end, the first two analysts joining me on Ticker Take are Justin Perucki and Michael Tian. Justin and Michael are the dynamic duo that make up our "No Moat Research Team". I'll leave it up to them to figure out who is Batman and who is Robin. Their focus is on uncovering investment opportunities in the vast universe of stocks that we rate "no moat".

Besides the endless search for market inefficiencies to capitalize on, you can expect timely, insightful, and (hopefully) witty commentary on whatever is news in the markets. I hope to be able to capture some of the conversations that go on in our equity research team that unfortunately end up on the cutting room floor because there's outlet.

I have no grand blueprint for Ticker Tape -- this is an experiment that I hope will grow over time as we add more analysts to the blog. We're going to have fun with Ticker Tape and I hope it will be just as fun for you to read.

Can a No-Moat be better than a Wide-Moat?

2008-06-13T14:59:04Z

"Buy wide moats at good prices." If you are a veteran Morningstar reader like me, you've probably seen this message so many times in so many manifestations that your brain immediately shuts down whenever you encounter it in a new form. While I sympathize, I’m not going to apologize for repeating myself, for this method tends to work pretty well over time.

However, to avoid putting you to sleep, I’m going to put a new twist on the concept of moats to kick off our new blog, and tie it into a part of my work at Morningstar, which entails looking at no-moat companies, a dusty and often forgotten corner of the our investing universe.

My message is simple: I’ll take a Growing moat over a Wide moat any day!

This may sound anathema, but it isn't at all when you think about it. The quality of a company’s existing business is often very apparent. Crack open the financials and whip out the calculator, and you can often tell if a business is any good in a few keystrokes. Sounds easy, right? Of course! And that's the problem. If it’s too easy, everyone else can figure it out too.

With its legions of investors, batteries of computers, and swarms of algorithms, the market is very, very good at discounting the past. But, fortunately for you, it’s not too smart about the future. And therein lies the opportunity.

Think about what happens when a company’s moat is growing. Its margins often grow, allowing it to invest ever larger sums back into itself, improving the business even further. Its earnings, and returns on capital and equity also grow, luring in even more investors--leading to "multiple expansion", in street parlance. Who cares whether the company had no moat, a narrow moat, or wide moat to start! The size and depth of the moat five, or ten years in the future is the only criteria that matters. In fact, if the company started out as a no-moat, it simply means that it has more room to dig!

On the flip side, think about what happens to a great business that starts a slow decline. Revenue growth often slows, margins shrink. Returns on capital and equity also shrink, and possibly become more volatile. The company often cannot profitably reinvest in itself at the same rate, leading to a downward spiral. At this point, the company probably isn't terrible. In fact, it may earn decent returns on capital for years, qualifying it for a moat. But I probably wouldn't touch it except at a thrift store price.

The market often anchors on the company’s past financials, and underestimates, or even ignores, the evolution of the business itself. Even us enlightened Morningstar analysts are hardly immune to this. To illustrate my point, I’m going to quote from some old analyst reports for Monsanto MON, dated 2001 to 2002. If you can believe it, we had rated Monsanto as a no-moat, high uncertainty company. Now, I consider Monsanto one of the most defensible, highest quality companies in the world.

This is what we said in 2001:
"Monsanto gets 70% of its revenue from its hugely successful Roundup line of herbicides and insecticides, but that product has lost patent protection; thus, competitors will be able to offer generic substitutes, which will erode margins in the coming years."

"But without major worldwide markets opening for GM seeds and crops, Monsanto will have difficulty differentiating itself from better-funded competitors, like DuPont's Pioneer Hi-Bred."

The following is the title of a report from 2002:
"Monsanto’s penchant for getting itself in hot water prevents us from recommending its shares."

Granted, if you read the full reports, the analysts in question (no longer at Morningstar FYI) recognized the growth potential of the business. But we dramatically underestimated the growth rate, the margin expansion, and the future value of Monsanto’s franchise--leading to a golden missed opportunity.

I personally believe that our no moat coverage universe is rife with such opportunities, just waiting to be discovered with some patience and a discerning eye. However, because these companies are rated no-moat, we seldom single them out for investor pitches. That’s where Justin Perucki, my colleague, and I come in. In the coming months, with a lot of elbow grease, we hope to unearth and bring you these hidden gems... So wish us luck!

An Energy Company Trading Near Its Lows?!?!?!

2008-06-11T22:35:54Z

With most energy stocks at all time highs, why is Breitburn BBEP trading near its lows? The units are yielding 9% to boot. Over a series of post, I will walk you through why I think the stock is cheap, a couple different ways to think about pinning a value on the company, and specific catalysts that should drive the stock from its current level towards its fair value.

Due to assumed cost of capital advantages and its tax-advantaged status, master limited partnerships (MLPs) like Breitburn rely on acquisitions for growth. To fund this growth, MLPs like Breitburn rely on a mix of debt and equity. This usually isn't a problem when the credit and capital markets are in good order. But as we all know, things haven't been in good order since last summer. Consequently, Breitburn's stock has taken it on the chin. The stock has rebounded over the past few months, but it is still off 40% from its high despite $135 oil and $12 natural gas prices. With a weakened stock price and the credit gravy train gone, making acquisitions is tough.

To make matters worse, Breitburn has had to deal with a fleeting shareholder base as well. First, Breitburn relied on a special type of funding—private placements in public equity (PIPEs)—to speed up the acquisition process last year. These investors accentuated the move down when they started heavily shorting Breitburn's shares to hedge their positions until the PIPE shares became freely tradable. Second, Breitburn's former parent Provident PVX announced in February that it was looking to sell the remainder of its U.S. interests by the end of the second quarter. Provident, a Canadian producer, owns 22% of the outstanding units and 95% of the general partner.

Last but not least, Breitburn has yet to achieve the production and distribution levels it targeted following the acquisition of Quicksilver's KWK Antrim Shale assets last September.

In my next post, I'll add some numbers to the mix to show why despite the ugly picture painted above that it pays to dig in the garbage.

To be continued…

(Disclosure: an internal investment fund I co-manage owns shares in BBEP)