While it is difficult to keep on top of the rapidly shifting environment, collectively, we find more opportunities to buy than sell shares at current levels. Because this event presents a sharp short-term economic fallout for many companies, we think this crisis will certainly favour firms with economic moats and financial strength.
We think there are a number of moaty names that investors should consider adding to their portfolios as well as heavily sold-down stocks that could see a good post-virus bounce. We can’t begin to suggest when equity markets may bottom out, but we like where we see good value versus risk.
While we anticipate the coronavirus impact to be taxing on global GDP growth and company profits in 2020, we don’t envisage long-lasting effects.
The market’s view seems to differ. The steep discounts to our fair value estimates in some sectors suggest the market is extrapolating the current weakness to persist much longer. This opens a raft of opportunities for investors willing to cut through the noise and instead, in a disciplined manner, assess the extent to which the pessimism regarding long-term corporate earnings is warranted.
For those in need of some assistance, here are 10 high-conviction, undervalued US stocks that have either little exposure to Covid-19 or overstated long-term implications.
US conglomerate 3M is involved in a number of industries and behind popular brands such as Scotchgard and Post-It notes. But market sentiment has turned against the company for three reasons: slowing organic growth as the wide-moat company matures; recent weakness in the auto, semiconductor, and Chinese markets; and litigation risks. Bears now maintain that 3M’s model is irretrievably broken.
We disagree. In our view, coronavirus fears now offer potential 3M investors an uncommon opportunity to own the shares of a well-run, defensive franchise. The effects and related fears over the virus will hurt the company’s supply chain and most of its short-term results, given 3M’s material geographic exposure to China. That said, we think the valuation remains too attractive to pass on, based on our $186 fair value estimate.
3M possesses a historical ability to re-tool its operations to capture higher-growing portions of GDP amid short-cycle headwinds. We point to 3M’s personal protective equipment division, where global demand for its N95 respirators now exceeds supply and could drive greater-than-expected division revenue growth.
Long-term secular drivers include an aging population, urbanisation and industrialisation trends, and a rise in chronic disease and surgical procedures. We expect that the more stable portions of the company’s portfolio should allow 3M to trade like a consumer healthcare stock, and we would not be surprised by a rerating in line with its historical norms.
As one of the global leaders in online commerce, wide-moat Amazon finds itself in a unique position amid the global coronavirus outbreak. As containment efforts hasten and more consumers isolate themselves, we believe certain Amazon services will see increased adoption.
The most obvious example is online grocery, which has accelerated “significantly” in recent weeks based on our discussions with logistics industry executives. With a spike in telecommuting, Amazon Web Services also stands to benefit from increased enterprise cloud computing, storage, networking/content delivery, and digital security usage. We also anticipate Amazon will benefit from increased demand for entertainment content.
While Amazon finds itself well positioned to capitalise on coronavirus-related demand, it could also face obstacles such as reduced discretionary spending. While we would expect online retail to outperform physical retailers during a quarantine situation, it is not immune to potential disruptions such as staffing availability. Additionally, we expect supply chain disruptions for Amazon and its third-party sellers to result in some shipment delays and product availability.
Still, we expect consumers to prioritise online shopping in the months to come. Amazon currently trades at a significant discount to our $2,400 fair value estimate.
BioMarin Pharmaceutical (BMRN)
BioMarin Pharmaceutical’s orphan drug portfolio and strong late-stage pipeline support a narrow moat. We think the market underappreciates the company’s entrenchment in current markets as well as its potential in new markets, particularly with its emerging gene therapy pipeline.
BioMarin has several products on the market to treat rare genetic diseases; these products generally see strong pricing and have limited competition because of a solid combination of patent protection, complex manufacturing, and the company’s close relationships with patients who rely on its therapies for chronic treatment. BioMarin currently trades at a significant discount to our $119 fair value estimate.
No-moat cloud computing and internet services firm CenturyLink has dropped in recent weeks to trade at about half of our $19 fair value estimate, with a dividend yield above 11%.
We think the stock has been hit especially hard because the market has become fearful of companies with highly leveraged balance sheets. However, we believe the transformation in CenturyLink’s business following its acquisition of internet provider Level 3 has left the company in a better position than most investors realise.
CenturyLink was aggressive in refinancing debt during 2019, pushing its maturities further into the future. We don’t expect the company will need access to credit markets until 2022. In addition, we don’t believe its business, which primarily provides networking solutions for enterprises and governments, is especially sensitive to the economy, so don’t expect a substantial downturn in the event of a global recession.
We also think its dividend would be on the chopping block only if financial market conditions remain depressed and the company becomes concerned about its ability to refinance some of its debt.
We don’t think CenturyLink has a compelling business growth story, but we see it as too cheap for a company that is relatively stable.
Wide-moat Comcast’s core cable business is in great shape and should see minimal impact from Covid-19. While its theme park business will be hurt, it was only 5% of revenue 2019.
Longer term, the park business is a key asset behind Comcast’s media efforts. The Sky acquisition added to the firm’s debt load, but the balance sheet remains solid.
Comcast’s valuation isn’t as attractive as it was in early 2018, during the battle for Fox, but the stock is still trading at a 30% discount to our $49 fair value estimate.
Wide-moat Corteva is trading at a significant discount to our $40 fair value estimate. The pure-play agriculture inputs company generates around half of its profits from seeds and the other half from crop chemicals.
Corteva manufactures all of its seeds locally, resulting in minimal exposure to international supply chain disruptions. In crop chemicals, the supply chain is more global, but this footprint is well diversified and not reliant on any single country. Further, the company currently has around a year of inventory on hand, which should provide some buffer.
Corteva’s largest market is US farmers, who account for around half of revenue. Following 2019, which saw the lowest US acres planted in over a decade, farmers are expected to plant more crops this year, which should translate to sales and profit growth in 2020.
Outside the US, our current expectation is that farmers will plant crops as usual in 2020 and Corteva should see normal demand, particularly for its premium products that help farmers increase yields by controlling pests. Additionally, we think the market is undervaluing the launch of eight new crop chemical products and the Enlist GMO corn and soybean seeds. These products should drive revenue growth and profit margin expansion in the years to come.
We believe narrow-moat Hanesbrands is in better shape to ride out the Covid-19 crisis than many other international apparel manufacturers. It has minimal product sourcing and sales in China, so should suffer limited direct impact from the most affected nation.
Hanes’ sales will certainly suffer if the crisis causes severe economic downturns in North America, Europe, or Australia. However, the company remained profitable throughout the 2008-09 financial crisis and its business rebounded nicely in 2010-11.
Hanes sells replenishment products that people buy regularly, regardless of the economy and over the long term, and we still believe the company can improve production efficiency.
Although the company is prioritising debt reduction, it pays an annual dividend of $0.60 per share and plans to repurchase $200 million in shares in 2020. Hanes currently trades at a significant discount to our $27 fair value estimate.
A recession would negatively affect the results of narrow-moat shopping mall owner-operator Macerich for the next two to four years, and a permanent change in consumer behaviour would lower the company’s long-term growth potential. The business is also facing a potential dividend cut as it tries to finance both a very high dividend and its renovation plans.
That said, we still like the company and think it screens as extremely attractive at current prices. We believe that Class A retail will be the winner among bricks-and-mortar retail and should see positive growth over the next decade, while the major bankruptcies and store closures will occur among Class B and C properties.
Macerich’s renovation plans should unlock a lot of value at its properties and provide significant tailwinds for earnings growth starting in late 2021. Also, because it trades at such a massive discount to net asset value, it could be a takeover target. The shares are currently trading at a significant discount to our $51 fair value estimate.
Norwegian Cruise Line Holdings (NCLH)
Narrow-moat Norwegian Cruise Line has a wide margin of safety to our $42.50 fair value estimate. Fears surrounding the coronavirus outbreak have weighed on travel stocks, and oversupply concerns have echoed through the cruise marketplace over the past few years.
While 2020 has a dour outlook, we believe the impact from Covid-19 will begin to diminish in 2021 as Norwegian’s brand power should still resonate with consumers. However, we have placed a very high uncertainty rating on the stock, given the uncertain duration of the outbreak and the lasting impact it could have on traveller perception.
In our opinion, current concerns are transitory and plenty of global demand remains untapped to support industry growth once the virus abates. Cruise companies are tapping into new geographies and demographics and Norwegian’s compelling value-added bundling and market-to-fill strategies, mean it is poised to pivot nimbly to capitalise on evolving consumer trends and increase average earnings per share growth again in 2021 as Covid-19 concerns dissipate.
We believe the market is underappreciating wide-moat Pfizer’s next-generation drugs, which should drive strong long-term growth. Further, the company’s pipeline drugs focus on areas of unmet medical need where pricing power is strong.
Pfizer is facing very few major patent losses over the next five years, which should also support steady growth. Lastly, the divestment of established products group Upjohn to Mylan creates a new entity with robust cash flows, likely supporting a strong dividend. The shares are currently trading at a significant discount to our $46 fair value estimate.
A version of this article first appeared on Morningstar.com