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5 US stocks tipped to succeed

Susan Dziubinski  |  11 Nov 2019Text size  Decrease  Increase  |  
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One of the US's most anticipated IPOs of 2019, Beyond Meat (XNAS: BYND), recently joined fintech Envestnet, pipeline company Equitrans and a few others in Morningstar's equity research stable.

Though Beyond Meat is a pioneer in the plant-based meat industry, we don’t think it has carved out a competitive advantage. As such, we're not convinced that BYND can earn excess returns on its invested capital over the next decade, reports analyst Rebecca Scheuneman. We’ve assigned it a no-moat rating.

But our analysts have initiated coverage of several other companies lately that they think can earn excess returns over the next decade – we've assigned these companies narrow Morningstar Economic Moat Ratings. Here's a peek at some of those stocks. Most are fairly valued today according to our metrics.

Here’s what our analysts had to say about each when initiating coverage.

Ulta Beauty (XNAS: ULTA)

Economic Moat Rating: Narrow
Moat Trend: Stable
Uncertainty: High
Morningstar Rating (as of 6 November, 2019): 3 stars

"We are initiating coverage on Ulta Beauty at a fair value estimate of US$242 and with a narrow moat rating. We view shares as fully valued at current levels. Our moat rating is based on Ulta’s brand intangible asset.

We believe the chain has achieved a strong following among women and teen girls (more than 33 million loyalty club members). It has become the largest specialty beauty retailer in the United States in terms of stores (more than 1,200), sales (USUS$6.7 billion in 2018), and number of products in the main beauty categories of makeup, haircare, skincare, fragrance, bath, and accessories.

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Ulta’s growth has been fuelled by store openings and impressive same-store sales growth. We forecast average annual same-store sales growth of 5 per cent over the next decade, which is below historical levels (7.9 per cent or better in every year from 2010-18) but above estimated market growth of about 3 per cent-4 per cent. We think Ulta’s success has made it an attractive partner for prestige cosmetics brands with limited distribution.

Ulta has spent heavily to build its brand in a difficult market. The firm has invested in digital marketing, data collection, merchandising, staff, and e-commerce to improve its standing among both shoppers and vendors. While we anticipate Ulta will continue to invest, the firm believes it can also achieve cost savings of US$150 million-US$200 million over the next three years.

We believe this plan, called Efficiencies for Growth, will be successful and allow for Ulta to continue to achieve annual operating margins of 12 per cent or better. On the downside, Ulta recently cut guidance for the first time in more than five years on slowing colour cosmetics and brand introductions. While disappointing, we do not believe this reflects any weakness in the company’s competitive position.

We assign a Standard stewardship rating to Ulta. CEO Mary Dillon and CFO Scott Settersten have been in their current roles since 2013. Ulta has achieved strong growth in sales, earnings, and cash flow under their guidance.”

(David Swartz, analyst)

Envestnet (XNYS: ENV)

Economic Moat Rating: Narrow
Moat Trend: Stable
Uncertainty: High
Morningstar Rating (as of Nov. 6, 2019): 3 stars

“We’re launching coverage of Envestnet with a US$62 fair value estimate and a narrow moat and stable trend rating. Envestnet provides wealth-management technology to financial advisers, broker/dealers, banks, and other financial institutions.

Its wealth-management technology includes performance reporting, rebalancing tools, customer relationship management, and financial planning software. In 2015, Envestnet acquired Yodlee, a leading provider of data aggregation software. Yodlee, now referred to as the data and analytics segment, makes up approximately 30 per cent of the firm’s net revenue (net of asset-based costs).

We believe Envestnet’s narrow moat is derived from switching costs in the wealth solutions segment.

For its second quarter, Envestnet reported adjusted revenue growth of 13 per cent, driven by wealth solutions revenue growth of 15 per cent and Yodlee revenue growth of 8 per cent. Excluding acquisitions, wealth solutions revenue grew 7 per cent from the year-ago period.

Given conversion activity and more favourable comps, we expect wealth solutions revenue to accelerate. Yodlee is facing recent hiccups to growth in its alternative data business as asset managers cut research budgets. In addition, an intellectual property dispute regarding its credit decisioning analytics product will weigh on Yodlee's growth in 2019.

Overall, we believe Envestnet will continue to benefit from the shift from commission-based advice to fee-based advice and advisors leaving the wirehouse firms to form their own independent practices. We believe Envestnet’s breadth of offerings is unmatched, particularly with its recent acquisition of MoneyGuidePro.”

(Rajiv Bhatia, analyst)

Broadridge Financial Solutions (XNYS: BR)

Economic Moat Rating: Narrow
Moat Trend: Stable
Uncertainty: Low
Morningstar Rating (as of Nov. 6, 2019): 2 stars

“We’re launching coverage of Broadridge with a US$116 fair value estimate and narrow moat rating. Broadridge is the leading provider of delivering proxy and mutual fund interims to end investors. In addition, Broadridge provides securities processing solutions and wealth management technology to broker/dealers. While many investors probably don’t know about Broadridge, they very likely received a shareholder communication from it.

Broadridge has two segments: investor communication solutions, or ICS, and global technology and operations, or GTO. The ICS segment provides communication services to banks, broker/dealers, asset managers, and wealth management firms. In fiscal 2019, Broadridge processed more than 6 billion investor and customer communications. The GTO segment provides trade processing, for capital markets, wealth management, and asset management firms. In fiscal 2019, Broadridge processed over US$7 trillion in equity and fixed-income trade per day.

Looking at the most recent financial results (the company's fiscal fourth quarter-ended in June 2019) and excluding the impact of an accounting change, Broadridge reported organic recurring fee revenue growth of 5 per cent. Equity proxy positions grew 6 per cent and mutual fund positions grew 5 per cent. GTO revenue grew 5 per cent organically, with gains in both equity processing and fixed-income processing.

Broadridge has issued fiscal 2020 guidance of GAAP EPS growth of 5 per cent-9 per cent and non-GAAP [generally accepted accounting principles] EPS growth of 8 per cent-12 per cent.

It expects recurring fee revenue growth of 8 per cent-10 per cent and total revenue growth of 3 per cent-6 per cent.”

(Rajiv Bhatia, analyst)

Equitrans Midstream Corp (XNYS: ETRN)

Economic Moat Rating: Narrow
Moat Trend: Stable
Uncertainty: High
Morningstar Rating (as of Nov. 6, 2019): 4 stars

“We're initiating coverage of Equitrans, an Appalachia-focused midstream firm, with a fair value estimate of US$18 per share. The narrow-moat entity is a newly streamlined and simplified C-Corporation, which we see as a plus, but it also faces multiple near-term issues. It is modestly undervalued at current prices, but we'd prefer a wider margin of safety before considering it a table-pounding buy, as our high uncertainty rating suggests a wider range of possible scenarios than most of our midstream coverage.

Equitrans is dealing with two major overhangs: the recent poor operational performance of its largest customer, EQT, along with the resulting management overhaul, and the deeply troubled Mountain Valley Pipeline.

Lower natural gas prices and the huge increase in associated gas production in the Permian (and the resulting pipeline constraints) have also raised concerns around slowing gas production growth out of the Appalachian region in 2020, providing a trio of near-term challenges.

Given EQT's operational ineptitude (higher well costs than peers and logistics challenges), and our high regard for the former Rice Energy's operational acumen (the newly installed management team at EQT), we're cautiously optimistic that EQT will be able to improve substantially.

EQT’s operational deficiencies have been clearly laid out, as have the planned fixes, which boosts our confidence in the eventual success. EQT's departments have already been slashed, and more than 20 per cent of the workforce has been let go. While the details regarding fee cuts are unclear, we think they would be offset by the improved logistics and well costs, resulting in higher production levels and more opportunities for value-accretive investments on the part of Equitrans.”

(Stephen Ellis, sector strategist)

RingCentral (XNYS: RNG)

Economic Moat Rating: Narrow
Moat Trend: Stable
Uncertainty: High
Morningstar Rating (as of Nov. 6, 2019): 4 stars

"We are initiating coverage of RingCentral with a US$232 fair value estimate, narrow moat, and stable moat trend rating. We think the company is attractively priced at these levels, with the unified-communication-as-a-service, or UCaaS, market in the early stages of migration from on-premises to the cloud, where RingCentral is a market leader.

RingCentral provides UCaaS software, which is replacing on-premises private branch exchanges that support telephones, with an easy-to-use, integrated communication application. We believe that RingCentral’s UCaaS offering plays a critical role (communicating with co-workers and outside entities) in the daily workflow of employees that will allow it to earn excess returns for the next decade.

RingCentral’s flagship offering is RingCentral Office, which now makes up over 88 per cent of subscription revenue. There are four tiers of RingCentral Office: essential, standard, premium, and ultimate. The tiers differ on the number of integrations enabled, the number of users allowed, and the number of toll-free minutes included. The choice of tier is generally correlated with the size of the organisation.

RingCentral Office provides users a unified application for communication and collaboration that includes voice, video, messaging, and conferencing capabilities. One benefit of the platform is that it allows the use of a single business number that can support all communication types via computers as well as mobile devices. This lets customers use their personal mobile device for business needs no matter where they are while maintaining the privacy of their personal cell phone number.

The transition from on-premises communication services to cloud solutions like UCaaS is in the early stages and offers RingCentral a long runway for growth. According to management, the market size for UCaaS is currently 10 million seats, with RingCentral taking 3 million.”

(John Barrett, analyst)

This article originally appeared on Morningstar.com

is director of content for Morningstar.com.

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