|Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.|
In this year’s difficult stock market climate, Morningstar has tried to help investors uncover opportunities. We’ve showcased undervalued stocks from our sector directors, for instance. Stocks with sturdy dividends. And those with rock-solid balance sheets.
Today, however, we pivot toward another recurring source for stock ideas: highly rated fund managers. First up: the managers at Oakmark.
“The Oakmark funds succeed with a patient, focused, and flexible value approach,” explains Morningstar director of equity strategies Katie Reichart. “The team aims to buy companies trading at a discount to their estimated intrinsic values, with a level of analysis that goes well beyond traditional price multiples. Management teams with an owner mentality are a must.”
Specifically, managers Bill Nygren and Kevin Grant, who lead the Gold-rated Oakmark Fund (OAKMX), added four new positions to the portfolio last quarter. Here’s what they–as well as Morningstar’s analysts–have to say about each.
American Express (AXP)
The duo picked up shares of American Express at just 11 times last year’s earnings per share–which they say is a cheap price for such a high-quality business.
“American Express has improved its cardholder value proposition in recent years by making significant investments in merchant acceptance, cardholder rewards and services, and small business payment tools,” explain Nygren and Grant in their latest commentary. “These efforts have accelerated both new card issuance and cardholder spending, and management has committed to reinvesting a portion of these incremental profits into further improvements in the company’s value proposition.”
The skippers expect that American Express will grow its business at a high-single-digit rate while reinvesting to protect its business from competitors.
“The organic growth that we expect, combined with potential share repurchases, should result in double-digit EPS growth in a typical year, while the company’s high returns and low credit risk should result in peer-leading results during the inevitable downturns,” they add.
American Express earns a wide Morningstar Economic Moat Rating, owing to a combination of competitive advantages across its three major segments.
“We believe American Express will be able to generate returns above its cost of capital equity as a result of fee income generated by its global merchant and network services business and its entrenched position in global commercial services,” explains analyst Colin Plunkett.
That said, we think the coronavirus will have a significant impact on American Express’ revenue this year: We currently expect the company’s revenue to decline 4.4% this year and rebound 10% next year. Although we recently decrease our fair values estimate to $125 from $141, shares currently have a Morningstar Rating of 4 stars.
“Trading at nearly a 40% discount to our fair value estimate, American Express is an exceptional bargain, in our view,” concludes Plunkett.
Match Group (MTCH)
Match Group’s portfolio includes the leading online dating brands–including flagship Tinder, which is the top dating platform in the world.
“Because online dating is a network-effect business where each user makes the platform more valuable for others, we believe a market leader like Tinder has significant scale advantages,” argue Nygren and Grant. “We believe this puts Tinder in an excellent position to address the more than 50% of singles in the U.S. and Europe who still haven’t tried online dating.”
Although the majority of Tinder’s users currently pay nothing, the pair thinks there’s plenty of opportunity to increase adoption of the service’s paid features. The company is growing revenue and operating margins top 30%.
“We don’t believe Match’s current valuation reflects the company’s combination of exceptional economics and long-term prospects,” they conclude.
Morningstar thinks Match Group boasts competitive advantages from its network effects and therefore assigns it a narrow economic moat rating. We think these network effects will allow the firm to make its infrastructure more scalable, streamline its operation, and create operating leverage, asserts senior analyst Ali Mogharabi.
We peg a fair value of $63 on shares, which are fairly valued today according to our metrics.
“Our projections represent a five-year compound annual growth rate of 16% for revenue and a five-year average operating margin of 40%,” details Mogharabi. “Our fair value uncertainty for Match Group is high, based on uncertainty regarding the firm’s member acquisition and retention costs.”
Workday is a software-as-a-service provider offering enterprise resource planning software to medium and large enterprises. Workday benefits from the trend of businesses worldwide embracing cloud computing to reduce costs and improve performance.
“When large companies transition their HR and finance applications to the cloud, they overwhelmingly choose Workday,” Nygren and Grant say. “As the global software market steadily transitions to cloud, we believe Workday will have a clear path to significant revenue growth.”
Yet despite the company’s dominant competitive position, the stock trades at a lower multiple of revenue than other software companies, they argue.
“We view today’s discount as an opportunity to invest in one of the world’s most innovative companies at a reasonable price,” the duo concludes.
Morningstar thinks Workday has built a narrow economic moat thanks to significant switching costs, says analyst John Barrett. COVID-19 will, however, damp revenue growth in fiscal 2021 because of the firm’s high-touch sales approach; layoffs and furloughs could also present a headwind. We expect a strong bounceback in fiscal 2022, though.
“We continue to look at narrow-moat Workday as an essential for both employers and employees and do not see the COVID-19 pandemic creating any sort of impetus for companies to change human capital management providers in the next few years,” argues Barrett.
Trading in 4-star range, shares appear undervalued.
Online discovery tool Pinterest’s stock-price slip to the midteens in the first quarter caught the eye of Nygren and Grant.
“Unlike many consumer Internet companies, users and advertisers are fundamentally aligned on the site,” assert the managers. “Pinterest provides its users with information that they are actually looking for as opposed to trying to distract them from a news feed or chats with friends. The company also gives advertisers access to an audience of people with high commercial intent along with the ability to integrate ads in a natural way.”
The site boasts a large and growing user base, and the site is in the stages of monetizing its platform.
“We believe that its shares are currently trading at a material discount to the company’s intrinsic value when benchmarking revenue and margin potential against its more mature Internet competitors,” they conclude.
Morningstar thinks Pinterest has carved out a narrow economic moat.
“We believe Pinterest has displayed a network effect among its users and has begun to compile valuable intangible assets, or user data, both of which we think it can effectively monetize and generate return on invested capital for at least 10 years,” notes Mogharabi.
Mogharabi admits that COVID-19 has lowered ad demand and will continue to do so during 2020–but we think the full-year impact will be partially offset by the firm’s strong first-quarter revenue and impressive user growth, he adds.
Shares are trading at 4-star levels as of this writing, suggesting that they’re undervalued by our metrics.
Oakmark manager David Herro and the team at Gold-rated Oakmark Global (OAKGX) reported in their quarter-end commentary that they, too, picked up shares of Pinterest last quarter. Two of their other new positions are outlined below.
EOG Resources (EOG)
The Oakmark Global team calls recent pickup EOG Resources “one of the best-positioned U.S. energy companies.” The group is especially impressed with EOG’s management team.
“It has focused intensely on capital productivity and, as a result, has made EOG a true low-cost producer,” the team argues. “It has also allocated the company’s capital effectively, giving EOG a strong balance sheet. This should enable the company to survive–and even benefit from—the currently stressed oil and gas environment.”
Morningstar assigns EOG a narrow economic moat rating.
“Until recently, very few shale producers were paying attention to shareholder returns, but EOG was one of them,” points out director Dave Meats. “The firm actually delivered excess returns on invested capital for five of the six years of 2009-14, before the downturn in global crude prices began … But a relentless focus on cost-cutting, productivity, and efficiency eventually paid off, enabling EOG to start earning its cost of capital again and qualifying the firm for a narrow moat rating.”
Although we recently pared back our fair value estimate to $61 from $86 to reflect the depressed oil outlook, we think markets have over-reacted, says Meats. EOG is undervalued, trading at 4-star levels as of this writing.
Prudential PLC (PUK)
Prudential may be headquartered in the United Kingdom, but Oakmark surmises that more than 90% of its value is derived from Asia, where it enjoys strong brand recognition, meaningful scale, and financial stability. The firm’s Asian franchise has produced impressive double-digit growth in profit and value-creation while generating a return on equity of more than 20% during the past decade, Oakmark reports.
“This strong performance has been driven by two structural tailwinds that we expect to continue for many years to come,” relay Herro and team. “First, Asian consumers’ increased wealth has significantly driven demand for insurance and financial planning products. Secondly, a massive demographic transition has created an aging population increasingly in need of retirement-related products and services. Yet, the penetration of life and health insurance in Asia remains relatively low compared to other markets.”
Indeed, Morningstar analyst Henry Heathfield calls the Asia business “the reported jewel in the crown.” Heathfield argues that the Asia business has done an especially good job of identifying underserved Southeast Asian markets, including Vietnam and Philippines. In the United States, its Jackson National Life Insurance business is the top seller of variable annuities. Nevertheless, we don’t think the company has built an economic moat.
In general, we think insurers do not benefit from competitively advantaged positions and therefore are not able to achieve a moat,” explains Heathfield. “Industry competition is fierce, and insurance products are commodities.”
Nevertheless, we think shares offer value, trading in 4-star range as of this writing.