The month of December--and, let’s face it, the first week or so of January--is typically one big blur. Between celebrating the holidays, traveling, and wrapping up loose ends at work, many of us are now wondering, “What did I forget to do? What well wish did I not make? What 'thank you' did I fail to say? And did I remember to write '2020' rather than '2019' on the check I sent to the gas company a few days ago?"
Given the busyness, you likely missed some notable equity ratings changes in December--I know I did, and I write this column each month! Interestingly, December was marked by a couple of Morningstar Economic Moat Rating downgrades and some fierce fair value estimate cuts.
Here are some highlights from our ratings activity last month.
Molson Coors (TAP)
We downgraded the economic moat rating of the brewer to none from narrow and its Morningstar Moat Trend Rating to negative from stable.
Analyst Nicholas Johnson notes:
“We see Molson Coors as disproportionately situated in secularly disadvantaged beer segments as the alcoholic beverage industry has fragmented. Consequently, we are downgrading our moat rating to none from narrow and believe that any vestiges of moatworthy traits will continue to erode. We have cut our fair value estimate to $60 per share from $66 to reflect the valuation implications of our moat downgrade as well as slightly less rosy margin assumptions, offset by a reduction in our systemic equity risk rating and consequent discount rate to align with our global beverage coverage. Investors and analysts have been losing faith in the name, and the stock has been meaningfully devalued over the past few weeks. While current levels don’t look egregiously cheap to us, we see a sufficient margin of safety for patient investors.
"There are remnants of moatworthy traits in Molson Coors' operations, specifically a meaningful volume and production footprint as well as a broad distribution apparatus. These are typically bastions of competitive advantages in consumer goods. Nevertheless, we believe the firm’s scale resides in beer segments with structurally higher bars for garnering moats, given the commoditized nature of the drinks. The brewer’s paucity of resonant higher-end trademarks, as well as its reliance on less economical license agreements, supports our view that its situation will worsen.
"Our fair value estimate is underpinned by fairly anemic performance on the top and bottom lines. Volume erosion should drive near-term revenue declines, and the attendant adverse effects on operating leverage should constrain margins in the medium term. Still, as management plows more resources into its above-premium portfolio, we think the top line can expand by low single digits longer term, leading operating margins to expand from 12.8% in 2018 to 13.3% in 2023.”
The stock is trading at 4-star levels as of this writing.
Premier (PINC)
Premier is a national group purchasing organization, or GPO, that provides supply chain services to large hospital systems and alternate outpatient locations. We downgraded its economic moat to none from narrow and its moat trend to negative from stable last month.
Analyst Soo Romanoff notes:
“Premier is a relatively new company--it came public in September 2013--but its cooperative concept has been employed across several industries and most commonly used by acute care organizations since the formation of the first healthcare group purchasing organization in 1910. The primary premise of a GPO is to pool purchasing volume to negotiate better pricing with manufacturing vendors. The healthcare GPO industry was formed through the collection of hospitals pooling purchase volume to share overhead costs, with profits openly shared on a pro rata basis on the respective investment into the cooperative. This structure provides an incentive for owner members to be vested.
"Premier is the only publicly traded healthcare GPO. It competes with numerous privately held companies as well as internally operated departments of very large for-profit and not-for-profit healthcare organizations. Since the initial government stimulus allowing GPOs to collect fees, increasingly competitive pressures have caused GPOs with limited differentiation to share portions of their gross administrative fees with clients in the form of rebates and volume discounts; as a result, collected (net) administrative rates have declined over time. Revenue offsets to this rate decline have largely been through product inflation, expansion of product offerings (increased contracts and utilization), and acquisitions. Although the company’s core supply chain segment is not materially differentiated from public and private peers, management continues to invest in its technology segment as it has potential for growth and differentiation if Premier is able to develop tools expanding functionality across a broad audience.
"We do not believe Premier possesses an economic moat, nor does the GPO industry as a whole. We've reduced our fair value estimate to $40 per share from $43 after incorporating the competitive landscape into our outlook.”
We think the stock is fairly valued today.
U.S. and Canada upstream oil and gas
Our new forecast for natural gas triggered fair value cuts among upstream oil and gas companies. Director David Meats notes:
“We are slightly reducing our fair value estimates for the U.S. and Canada upstream oil and gas segment to reflect our updated midcycle forecast for U.S. natural gas, which is $2.80 per thousand cubic feet (down from $3). The decrease primarily reflects significant cost cuts among U.S. natural gas producers operating in low-cost shale plays, which we attribute mainly to ongoing efficiency gains rather than cyclical dips in service pricing (making them sustainable, in our view). Nevertheless, our estimate remains higher than current strip prices.
"The shale revolution transformed the U.S. natural gas supply cost curve by unlocking prolific sources of low-cost unconventional production, like the Marcellus Shale. At the same time, it unleashed a tidal wave of incremental supply from tight oil fields that yield natural gas as a byproduct (associated gas). The U.S. is awash with cheap natural gas, and prices have swooned as a result; Henry Hub plunged 25% during 2019.
"The decline has gone too far, however. At current prices, only the highly productive 'sweet spots' of each shale basin are profitable, and producers have responded with significant spending cuts. Consequently, a supply gap is emerging. We think the market is underestimating the build-out and utilization of U.S. liquefied natural gas export facilities, which are a sink for U.S. natural gas, and domestic demand growth will also surprise on the upside because of rising consumption in the electric power sector. To keep the market balanced, U.S. producers must accelerate operations in low-cost shale plays, but current prices offer no incentive to do so. Our marginal cost estimate for U.S. natural gas, $2.80/mcf, is the midcycle level that should induce the right level of activity.”
The impact of the change of the updated forecast on our fair value estimates rests on two things: the financial leverage of the company and the ratio of oil to gas in the firm’s production mix, says Meats. More-leveraged companies saw more-significant fair value cuts, as did those companies with high exposure to gas. Among the deepest cuts: Antero Resources (AR) (43% cut), Cabot Oil and Gas (COG) (30%), California Resources (CRC) (38%), Gulfport Energy (GPOR) (50%), and Range Resources (RRC) (45%). All of these names are fairly valued as of this writing.
