The equity markets have had a volatile few weeks, and that’s unlocked a few bargains to be had. According to Morningstar Direct data, as of October 6th, 2020, there were more than 50 Canadian stocks that were trading below our fair value estimates. All the top 10 cheapest stocks were in oil and gas or marijuana companies, which makes sense, as both these sectors have been beaten down this year.
However, it is also important to remember that none of these cheapest stocks have an economic moat. The Morningstar Economic Moat Rating represents a company's sustainable competitive advantage. A company with an economic moat can fend off competition and earn high returns on capital for many years to come. A company whose competitive advantages we expect to last more than 20 years has a wide moat; one that can fend off their rivals for 10 years has a narrow moat; while a firm with either no advantage or one that we think will quickly dissipate has no moat.
Today, we decided to look at Canadian stocks that are trading below our fair value estimates, and also have an economic moat. 19 stocks made the list. We’ve listed the top 10 of them in the table below.
Of the 10, four are banks and three are oil and gas companies. Two of them have a ‘Wide’ economic moat, while the rest are narrow. Here’s the list:
| Name | Economic Moat | Moat Trend | Price / Fair Value | Fair Value Uncertainty |
| Cameco Corp | Narrow | Positive | 0.64 | High |
| Nutrien Ltd | Narrow | Stable | 0.65 | High |
| Enbridge Inc | Wide | Stable | 0.69 | Medium |
| Bank of Nova Scotia | Narrow | Stable | 0.80 | High |
| The Toronto-Dominion Bank | Wide | Stable | 0.80 | High |
| Bank of Montreal | Narrow | Stable | 0.80 | High |
| TC Energy Corp | Narrow | Stable | 0.81 | Medium |
| Rogers Communications Inc Class B | Narrow | Negative | 0.82 | Medium |
| Pembina Pipeline Corp | Narrow | Stable | 0.83 | Very High |
| Canadian Imperial Bank of Commerce | Narrow | Stable | 0.85 | High |
Morningstar Data as of October 6, 2020
The more eagle-eyed of our readers have noticed that though our Morningstar equity analyst Eric Compton covers all the major Canadian banks, only two of them, Royal Bank of Canada, and Toronto Dominion have wide moats, while most of the other are narrow. There’s a reason for that.
“Royal Bank of Canada and Toronto Dominion are the two largest Canadian banks and they both tend to have the most dominant franchises at home. While their Canadian peers also produce decent returns, the individual franchises are often less strong in comparison. Toronto Dominion and RBC tend to have dominant market share in many categories, including number-one or number-two share in most key retail banking products, in key commercial banking products, investment banking, and also key exposures to moaty nonbank businesses, such as wealth management,” he explains.
The other wide-moat stock on the list is the rare triple threat Enbridge – undervalued, with a wide moat, and with a high dividend yield.
Morningstar analyst Joe Gemino slightly lowered his Canadian fair value estimate for wide-moat Enbridge to $56 from $57 to account for the uncertainty around the future of the Line 3 replacement pipeline. “We are weighting the probability that the pipeline is built and fully operational at 80% and that the pipeline is protected by its integrity replacement status at 20%. There are no changes to our U.S. fair value estimate,” he says. He adds that the company remains one of the top picks in the Canadian energy sector.
Line 3 was granted integrity replacement status by Canada’s Energy Regulator, meaning that Enbridge can recoup its capital, expenses, and earn an return on capital for any capital that’s spent on the pipe – even if Line 3 isn’t up and running. "Our latest research concludes that we think there is an 80% chance that L3 is built, but in the chance that its not – 20%, we think that the company will be able to earn some return on its investment, just not at the same level as if the pipe was built, but more than if the capital was stranded. We think the market is mistaken to price Enbridge as if oil prices will remain weak forever. However, we do not expect the market's concerns will be fully addressed for some time, which can lead to volatile swings in the stock. We advise investors to stay the course while getting paid a handsome 8.4% dividend. In the end, we believe Enbridge's long and winding road will lead to 45% upside,” he says.
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