Call me nosy, but I love looking at top ten holdings. I recently looked at the biggest holdings of Morningstar Gold Medalist rated funds, hunting for shares that also command a five-star Morningstar rating. This indicates that our equity research team believes it is trading at an attractive discount to our fair value estimate.

Criteria 1: Gold medalist funds

Morningstar’s Medalist ratings indicate which funds and ETFs Morningstar believes are likely to outperform a relevant index or peer group on a risk-adjusted basis over time. Funds and ETFS are evaluated on three key pillars (People, Parent, and Process). These are coupled with a fee assessment before being ranked against other funds in the same Morningstar Category, which represents funds and ETFs that follow similar investment strategies.

Criteria 2: Five star stocks

A five-star rating means our analysts think that a stock is trading at an attractive discount to our fair value estimate. These shares may represent an opportunity if they align to your investment strategy. I wanted these stocks to be in the fund’s top ten holdings as per the latest Morningstar data (generally March 31st).

These positions may have fallen in value or been sold since then. But it’s the best way I could think of to find cheap stocks with the seal of approval from high quality managers. In the end, only four stocks met this criteria.

Here’s what didn’t make the list:

• There were no major banks
• No technology companies
• No real estate shares
• And no miners

Unsurprisingly, none of Mark’s latest three ASX shares to avoid made the cut either. So, what did?

TPG Telecom ★★★★★

Moat rating: Narrow
Current Price: $4.59
Fair Value Estimate: $6.60
Uncertainty: Medium

As of March 31st, TPG Telecom (ASX:TPG) was the second largest holding in First Sentier’s Gold Medalist rated Australian Small Companies Fund. The fund has typically displayed a mild growth lean, though our manager research analyst notes holdings include a healthy mix of names across the value-growth spectrum.

TPG Telecom’s merger with Vodafone in 2020 saw it join Telstra and Optus as Australia’s third heavyweight telco. Our analysts have assigned TPG a narrow moat due to the efficient scale of its fibre infrastructure and existing customer base in Australia. This means that TPG can spread the costs of technology upgrades, advertising and content rights bidding over a large customer base, which reduces per-subscriber costs and puts TPG in a superior position against many competitors.

The capital costs required for a new entrant to replicate even a small part of TPG’s infrastructure, scale, and brand power would be prohibitive, especially in a relatively small country such as Australia and a relatively mature industry with low single digit annual growth.

TPG’s shares have been weighed down by slower earnings growth as it invests heavily in rolling out 5G. There have also been concerns that major shareholders will sell down their positions after the post merger lock-up period. Morningstar’s Director of Equity Research Brian Han thinks these concerns are more than reflected in the share price, especially given the longer-term tailwinds from 5G adoption and TPG’s increased focus on mobile. He thinks TPG shares screen cheaper than any other company under our telecoms coverage in Australia and New Zealand.

Although the rollout of Australia’s National Broadband Network (NBN) poses a real threat to profitability in TPG’s consumer broadband segment, Han thinks TPG earnings can recover over the medium term thanks to a more rational mobile market and growth in its fixed wireless and corporate segments. At a price of $4.40 on May 16th, TPG’s shares were around 30% below Morningstar’s estimate of fair value.

Healius ★★★★★

Moat rating: No Moat
Current Price: $1.27
Fair Value Estimate: $3.00
Uncertainty: Medium

At the end of Q1, Healius (ASX:HLS) was a top-ten holding for Perpetual’s Gold Medalist rated ESG Australia Share fund. The fund has historically shown a bias towards mid- and small caps, with an underweighting to large caps. This is predominantly driven by the strategy’s environmental, social, and government screening process, combined with Perpetual’s quality and value filters.

Healius is a leading provider of pathology and medical imaging services. It was renamed from its former moniker Primary Healthcare in 2018 and has gone through a strategic overhaul, looking to new sources of strategic growth and trying to rectify prior underinvestment in infrastructure. Healius gets virtually all of its revenue directly from Medicare via bulk-billing in pathology and imaging.

Morningstar Equity Analyst Shane Ponraj does not think Healius has a moat. The company is a price taker due to fixed fee Medicare arrangements and does not have a scale-derived cost advantage in the way that Sonic Healthcare does. The firm is also at a technological disadvantage to Sonic due to many years of underinvestment that it is now seeking to address.

Healius shares have fallen with other pathology shares. In a recent report on the industry, Ponraj says that investors appear to doubt that pathology firms can return to pre-pandemic levels of profitability. He believes that the chance for higher prices and stabilizing costs could prove them wrong. He also sees population growth, aging demographics, higher incidence of diseases and wider adoption as solid long-term demand drivers for the industry. At a price of $1.27, Healius shares traded around 57% below his $3.00 fair value estimate.

Bapcor ★★★★★

Moat rating: Narrow
Current Price: $4.62
Fair Value Estimate: $7.30
Uncertainty: Medium

Perpetual’s top-rated ESG Australia fund also held a top ten position in Bapcor (ASX:BAP) as of March 31st. The share price has recently dropped and could provide an opportunity for investors to buy this narrow-moat business at a low price.

Bapcor is a major supplier of spare automotive parts and other vehicle accessories and serves retail and trade customers through several brands including Burson, Autobarn and Autopro. Our Bapcor analyst Angus Hewitt assigned the firm a narrow moat rating due to brand intangibles and cost advantages versus smaller peers in its trade and retail wings. Bapcor’s network and ability to wait for slower moving parts to sell means it can provide a broader range of parts more quickly than smaller competitors.

As my colleague Mark LaMonica outlined in his recent article, Bapcor shares recently dived 20% after a poor trading update. There have also been doubts over the company’s ability to thrive after the departure of former CEO Noel Meehan. Morningstar Equity Analyst Angus Hewitt cut his profit forecast and fair value estimate for Bapcor after the update but thinks Bapcor’s strategy and economic moat remain intact. He expects continued share gains in trade as Bapcor’s network flexes its competitive strengths against smaller peers.

At a price of $4.62, Bapcor traded at a 37% discount to Morningstar’s fair value estimate of $7.30.

Woodside Energy ★★★★★

Moat Rating: No Moat
Current Price: $27.28
Fair Value Estimate: $45.00
Uncertainty: Medium

As of March 31st, Woodside Energy (ASX:WDS) comprised over 6% of Dimensional’s Gold Medalist rated Australian Value Trust. Like other offerings from Dimensional, the Australian Value Trust employs factor tilts grounded in the research carried out by Eugene Fama and Kenneth French. From a starting point of the ASX’s cheapest 45% of stocks by book value, further value, size, and profitability factors are applied.

Woodside is Australia’s premier oil and gas player, with operations encompassing liquid natural gas, natural gas, condensate and crude oil. Morningstar Equity Analyst Mark Taylor sees Woodside’s low-cost LNG interests as attractive and feels the company also benefits from its unparalleled experience of LNG in the Australian market and long-held off-take agreements with several Asian utilities. However, the firm does not appear to have an economic moat.

Woodside’s share price has struggled since September 2023. The company also reported a 7% decline in first-quarter 2024 production but maintained its 2024 guidance for production and capital expenditure. Mark Taylor’s fair value estimate of $45.00 assumes relatively flat earnings before interest, taxes, depreciation and amortisation (E“BITDA”) over the next decade as lower commodity prices offset production growth. At a share price of around $27.28, Woodside is trading 40% below this level.

Terms used in this article

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.