No, the headline isn't a typo. Just because a company has been downgraded by Morningstar doesn't mean investors should sprint for the exits.
A downgrade in any one of Morningstar's measures - an economic moat rating, a fair value estimate, uncertainty - isn't a sell signal. Rather, a change indicates a recalibration of our long-term expectations. Companies that have experienced downgrades (or upgrades, for that matter) can still be undervalued or overvalued, depending on where the stock is trading relative to our fair value estimate. As a result, investors who read too much into downgrades may be missing out on opportunity.
Today we're looking for inexpensive, high-quality companies that have undergone a recent fair value downgrade. Specifically, we've screened for wide- and narrow-moat stocks with stable or positive moat trends trading in 4- or 5-star range whose fair value estimates have been cut by 10 per cent or more since 1 November, 2018.
Six companies made the list.
Blackbaud: Cloud move a boon
A leading provider of relationship-management software for non-profits, healthcare organisations and educational institutions, Blackbaud (BLKB) has carved out a wide economic moat thanks to its high customer switching costs and intangible assets within the social good community, says analyst Andrew Lange. Last week, we trimmed the firm's fair value rating by 15%.
"After reassessing our long-term view on Blackbaud's growth and margin profile, we are lowering our fair value estimate to US$87 per share from US$102," explains Lange. Despite the fair value haircut, Lange thinks the firm's entrenched leadership position is secure, and the move to a cloud-based business model will lead to better lifetime value from customers.
Ctrip: Stronger position in China travel
The largest online travel agency in China, Ctrip (CTRP) earns a narrow economic moat rating as a result of its strong network effect, says analyst Chelsey Tam. The firm has built a virtuous ecosystem serving both individual travelers and travel service providers, she argues. We snipped the firm's fair value by 18% in November.
However, Ctrip has strengthened its leading position among Chinese online travel agencies and will continue to benefit from rising disposable incomes and demand for domestic and international travel.
GE: New CEO set to unlock value
The narrow-moat conglomerate GE (GE) continues to streamline, announcing this week it will create a new independent entity consisting of its digital industrial Internet of Things offerings; it also plans to sell large parts of ServiceMax (its field service management software).
Morningstar slashed GE's fair value estimate by 16% in November 2018. Conceding that a successful multiyear turnaround won't be easy, analyst Josh Aguilar argues that new CEO Larry Culp should be able to unlock GE's considerable asset value over the long term. Culp is implementing several measures including aggressive cost cutting, separating its healthcare and Baker Hughes divisions, exploring asset sales, and driving improvements to operating efficiency.
Johnson Controls: Improving fundamentals closing gap
In November, Johnson Controls (JCI) announced it had reached an agreement to sell its power solutions business; the sale is expected to close by June 2019. After the sale is complete, the narrow-moat firm's main focus will be its building technologies and solutions segment, which manufactures, installs, and services HVAC systems, building management systems and controls, industrial refrigeration systems, and fire and security solutions. The sale triggered a re-evaluation of our fair value estimate, based on Johnson Controls' simplified business.
"We think a prudent capital allocation strategy in tandem with a simplified business model that is clearly showing improving fundamentals will help Johnson Controls close the gap between its current stock price and our estimate of its intrinsic value," says analyst Brian Bernard.
Headwinds favouring Tencent
Shares of the Chinese Internet giant - whose multitude of businesses include dominant social media and gaming services - were rocked in 2018, as the Chinese government stopped approving licenses for new games. As a result of the freeze and its impact on Tencent's (TCEHY) gaming revenue, Mornignstar shaved 16% off its fair value estimate.
Longer term, regulatory headwinds could work in Tencent's favor: Smaller game companies will be squeezed out, says Tam, and Tencent will be able to gain market share.
Weibo: Under-rated network effect
Narrow-moat Weibo (WB) is the largest social media platform in China. The firm's moat stems from its network effect: It claims 392 million monthly active users and 172 million daily active users, says Tam. Morningstar lowered its fair value estimate by 12% in mid-December 2018.
That said, Tam says its network effect remains strong: "We continue to think Weibo is undervalued for long-term investors."
