Today kicks off day one of the annual Morningstar Investment Conference. For the next three days, we’ll be soaking up insights from some of the industry’s best practitioners.
To get into the right mindset, we thought we’d take a peek into the latest portfolios of some of our favorite large-cap fund managers to see what they’ve been buying. Although the stock market enjoyed significant gains during the first quarter, three top managers found new ideas within buying range.
Michael Keller, who steers BBH Core Select (BBTEX), which has Morningstar Analyst Rating of Silver, takes a disciplined, long-term-focused approach to stock-picking. He favors profitable companies with strong balance sheets that throw off plentiful cash--and he’ll only buy when their stocks trade 25% below his estimated intrinsic value.
Keller initiated two new positions during the first quarter: Costco (COST) and Colgate-Palmolive (CL). He told shareholders in his latest commentary that both stocks were facing overly negative investor sentiment coming into the new year.
Despite the structural shifts in the U.S. retail industry, Keller thinks warehouse club retailer Costco can remain a leader, thanks to its size, scale, and unique shopping experience.
“We believe the company’s key advantage derives from a ‘flywheel’ effect in which low prices, quality products and skilled merchandising drive strong customer loyalty and store traffic, which in turn enables the company to further drive its pricing, sourcing and merchandising leadership via scale and data insights,” he argues. Moreover, Costco boasts membership renewal rates of more than 90% in the United States and Canada, even as management has nudged up fees over time.
Morningstar assigns Costco a wide economic moat, stable moat trend, and low uncertainty rating. We also rate its stewardship as exemplary. We agree that Costco’s differentiated business model should allow it to continue to generate outsize returns in the foreseeable future, notes analyst Zain Akbari.
“We believe the high renewal rates suggest Costco benefits from a strong brand that stands for high quality and low cost; combined with its exceptional productivity, this leads to strong returns on invested capital, most recently 19% in fiscal 2018, more than double our 7% cost of capital estimate,” Akbari notes. “We expect the firm will continue to generate excess returns over the next 20 years.”
Shares are highly overvalued by our metrics, trading at Morningstar Rating levels of 1 star.
Keller’s purchase of home and personal care product manufacturer Colgate-Palmolive was driven in large part by the company’s global footprint in oral care specifically.
“[T]he oral care category is an attractive, high-margin, high-return business with substantial opportunity for growth given low penetration in much of the company’s footprint,” he says. “We believe that Colgate’s market-leading position in nearly every market in which it participates combined with the attractiveness of its footprint in regions with strong secular tailwinds will enable it to capture meaningful growth in the category over an extended period.”
Morningstar assigns Colgate-Palmolive a wide economic moat rating and stable moat trend, a low uncertainty rating, and exemplary marks for stewardship.
Sector director Erin Lash admits that the company’s performance has been tepid during the past few years.
Despite recent pressure, we don't posit its competitive edge is showing signs of decay,” she quips. “While a few ancillary factors have constrained its top line, we attribute a portion of the margin pressure to an uptick in inflationary headwinds and the decision to boost ad spending, which we believe stands to support its leading brand mix and value-added innovation.”
Shares are fairly valued today according to our metrics.
Chuck Bath and Austin Hawley, who head up the Gold-rated Diamond Hill Large Cap (DHLRX), look for companies trading below their estimated intrinsic value, modeling cash flows on a five-year time horizon. The result is a portfolio with a high-quality bias.
During the first quarter, the duo picked up shares of T-Mobile US (TMUS), noting that it is the only U.S. wireless carrier continuing to enjoy meaningful unit growth.
“The company is buoyed by three major tailwinds: sustained subscriber momentum, free cash flow conversion, and value accretion from its potential merger with Sprint (S),” they explained in their recent commentary. “Although a completed merger with Sprint will deliver significant synergies due primarily to network rationalization, on a standalone basis T-Mobile’s momentum is also compelling as the company continues to build out its network to previously underserved areas in the U.S.”
Morningstar assigns T-Mobile a no-moat rating, a positive moat trend, and high uncertainty.
“T-Mobile’s turnaround has been remarkable,” says sector director Mike Hodel. After its merger with MetroPCS and a fresh set of managers, the company has shifted from a market share loser to the industry’s dominant share taker, he says. However, the firm hasn’t yet earned returns on capital that exceed our estimate of its cost of capital and as such, doesn’t earn an economic moat.
T-Mobile is fairly valued today according to our metrics.
Bath and Hawley also took a position in asset manager KKR (KKR) last quarter.
“We believe the company has been undervalued, and that its conversion to a C-Corp and a more simplified reporting structure will allow potential investors to better understand its business model and ability to compound book value,” they explained.
Morningstar analyst do not currently cover KKR. However, according to our quantitative ratings, KKR is a narrow-moat stock with high uncertainty; shares are trading in 4-star territory.
Bill Nygren and Kevin Grant, skippers of Gold-rated Oakmark (OAKMX), practice a less-conventional value strategy. They favor companies poised to grow per-shares value and are mispriced relative to what a rational buyer would pay to own the entire business.
“Over the past five years, Constellation’s beer segment--which includes brands such as Corona, Modelo and Pacifico, among others--has grown its sales volume and revenue at a 10% and 12% CAGR, respectively,” they relayed to shareholders in their latest letter. “The company was able to accomplish this impressive growth during a period when industry volume growth remained relatively flat.” Nevertheless, they argue that Constellation trades at a meaningful discount to other consumer packaged goods companies that are experiencing slower growth. Nygren and Grant also think that the firm’s strategic partnership and large ownership stake in the world’s largest publicly traded cannabis company, Canopy Growth Group, could generate significant opportunity over time.
Morningstar assigns Constellation Brands a narrow economic moat, stable moat trend, and medium uncertainty rating.
“With six of the top 15 imported beer brands in the U.S., Constellation maintains entrenched relationships with distributors and retailers that have relied on these brands to drive growth,” explains analyst Sonia Vora. Those relationships will prove valuable as the firm seeks shelf space for new offerings. Moreover, demographic trends in the United States should benefit the company.
Shares are fairly valued according to our metrics.
Nygren and Grant also purchased shares of ratings and benchmark provider S&P Global (SPGI) earlier this year. They note that exchange-traded funds and mutual funds tied to the firm’s indexes are gaining market share as the passive-investing market continues to flourish. And of course the firm remains an essential player in the credit-rating business.
“Each of S&P Global’s segments share the common characteristic of providing value for customers that is much greater than the prices they charge,” they argue. “As a result, S&P Global is able to raise prices and generate above-average earnings growth.” They think the firm has a long runway for growth.
Morningstar pegs S&P Global with a wide economic moat rating and stable moat trend, as well as a medium uncertainty rating.
“S&P Global enjoys one of the widest moats in financial services,” says analyst Colin Plunkett. Credit ratings remain the firm’s most important segment, where there are significant switching costs. The firm’s Dow Jones Indexes segment is fast-growing and high-margin, and its market and commodities intelligence segment also benefits from switching costs and intangible assets, he notes.
We think shares are fairly valued today.
Susan Dziubinski does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.