We talk a lot about Economic Moats at Morningstar. Investing in a company that isn’t facing major threats from competitors or activity in the market means it is more likely to provide a stable return in the future too.
This is why we developed the Economic Moat rating, which is an indicator of competitive advantages over time. We use three ratings: none, narrow and wide moats. The focus is often on those with the strongest advantages – for example, these are the funds that hold the most moaty stocks – but what about the stocks that aren’t satisfied with where they’re at and are working to expand the distance between themselves and the competition?
In addition to being awarded a narrow economic moat rating, these five European stocks are all on a positive moat trend, meaning they are strengthening their positioning.
Carl Zeiss Meditec (AFX)
German Carl Zeiss Meditec supplies microscopes, diagnostic equipment, refractive lasers, and cataract equipment and lenses. It is one of two companies in the duopoly of microsurgery, a market it occupies 50% of. The company is a subsidiary of optical conglomerate Zeiss Group. As the current share price is €185.05, we consider it to be severely overvalued, trading 189% higher than what we consider its fair value to be – earning it a Morningstar Rating of 1 Star. That said, it has provided its investors with a 70.48% return so far this year.
Aaron Degagne, equity analyst at Morningstar, believes the company has earned its narrow economic moat rating based on its assets as well as high switching costs. Moreover, about one of 20 people end up getting laser eye surgery, and if this rate increases as a result of greater affordability and better technology, Zeiss could benefit from higher baseline sales.
Delivery Hero (DHER)
Delivery Hero is one of the fastest-growing food delivery operators in the world. It’s exposed to regions with attractive long-term structural characteristics and is according to equity analyst Ioannis Pontikis well positioned to benefit from the digitisation of food delivery orders. The company is headquartered in Germany but operates in 49 countries across five continents. We believe it to be fairly valued, giving it a 3-Star rating. It is down 2.99% so far this year, but it has returned 36.18% annually over the past three.
Pontikis adds that Delivery Hero has moatworthy competitive advantages in Europe, Middle East/North Africa (MENA) and Asia, with parts of its business operating at a profit and others still in development. Operations in MENA and Asia markets are particularly well-poised for growth and also have the potential to increase the barriers to entry.
Dassault Aviation (AM)
The cheapest of our moaty stocks of tomorrow is Dassault Aviation, the French defence and aviation manufacturer. It has an entrenched relationship with the French defence department and is one of three global suppliers of large, long-range business jets. Plus, equity analyst Joachin Kotze is positive about medium-term prospects due to a solid defense order backlog, the potential to regain share in the business jet market, and the opportunity to grow support and service revenue. While it has seen losses of 14.12% on a three-year annualised basis, it has managed to grow by 8% in 2021 so far. Trading at a 40% discount, we have awarded it 4 Stars.
The moat rating is based on its intangible assets, high level of engineering expertise. We also believe its ability to develop military fighter jets constitutes a wide moat, while business jets and spare parts are awarded a narrow rating. Plus, growth in aftermarket revenue could see a shift to more recurring revenue.
InterContinental Hotels Group (IHG)
The UK hotel chain InterContinental is an industry leader with 17 brands under its umbrella, ranging from InterContinental to Holiday Inn. We expect the company to expand its room share by 3% over the next decade, above the 1.8% supply increase we estimate for the U.S. industry. It is a leader in outsourced properties, as 99% of its hotels are outsourced or franchised – and it has announced plans for a new luxury brand. It has returned -2.90% so far this year and -0.80% annually over the past three years, but Morningstar believes it is set to return to pre-Covid levels by 2023. At the moment, it is trading at what we think is fair value, earning it 3 Stars.
IHG is considered a narrow-moat stock because of its brand and expansion forecasts, as well as high switching costs. The franchise contracts usually last 20-30 years and termination means significant costs to renovate and rebrand to meet new brand specifications. Moreover, it boasts one of the biggest loyalty programmes in the industry, with 100 million members.
Dutch Heineken (HEIA)
Heineken is the second-largest brewer in the world, housing names like Amstel and Strongbow, with the leading position in many European markets. The Dutch beer giant recently revealed a “green diamond” strategy to ensure long-term value creation, which it hopes to do through a focus on growth, profitability, capital efficiency, and sustainability and responsibility. We believe it is currently trading at a 10% premium, meaning it is slightly overvalued with a 2-star rating. It has grown 2.05% in 2021 so far and 3.74% on a three-year annualised basis.
Morningstar believes its moat is growing. It has earned a narrow economic moat from cost advantages that helps it sustain its market shares, and intangible assets, particularly in its strongest markets. Here, Heineken has relationships with its customers in both the on trade and off trade that allow it to react quickly to negative competitive events. And despite being slightly overvalued, we do believe in the company’s long-term growth opportunities in emerging markets and through its premium portfolio.
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