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9 essential US stocks

Susan Dziubinski  |  24 Apr 2020Text size  Decrease  Increase  |  
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During the COVID-19 pandemic, US state officials have been deciding what businesses are “essential” and can therefore remain open during stay-at-home orders. Healthcare facilities and pharmacies are, of course, necessary. Grocery stores are as well. Gas stations, banks, and restaurants offering take-out make the cut. And in many areas, home improvement and liquor stores do, too.

Controversy erupted last week, however, as Florida officials redefined the term “essential”: They deemed World Wrestling Entertainment to be an essential business. The WWE, which maintains a sizable training facility in the state, can now resume broadcasting from that facility as long as its events don’t include a live audience. A Stone Cold Stunner, indeed!

Today, we’re steering clear of controversy. Instead, we’re sharing several undervalued stocks with Morningstar Economic Moats of wide or narrow, hailing from industries that most would agree are “essential” today: restaurants offering takeout, banks, and pharmacies. All are trading in 4- and 5-star range as of this writing, suggesting they’re undervalued. Notably, no grocery or home improvement stores look undervalued by our metrics.

US stocks

Morningstar in the US recently published updates on six companies from the list:

Here’s our latest thinking on the three other names from the group:

Dunkin Brands DNKN

“The global food-service industry has come under pressure as several markets have restricted dine-in service in an effort to curtail the coronavirus outbreak. Restrictions vary by geography, but even in markets where carry-out and drive-thru orders are still permitted, we expect severe guest count declines for at least the next two months and an uneven traffic recovery into the back half of 2020.

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Nevertheless, we believe investors should prioritise those firms that have the scale to be more aggressive on pricing near-term (value-oriented players tend to outperform during economic shocks), developed robust mobile platforms, and possess healthy balance sheets. In our view, Dunkin Brands satisfies the value and mobile technology criteria, and while we believe some franchisees will experience severe distress, we think the company offers a dynamic global consumer growth story.

In our view, Dunkin's long-term cash flow potential is augmented by a strong brand intangible asset and franchisee system, particularly in the Northeast U.S. We believe Dunkin' can extend its brand reach beyond core markets, supported by solid franchise unit economics, national advertising efforts, and more technological-leveraged and drive-thru-focused restaurant formats. Franchisees own all Dunkin' Donuts and Baskin-Robbins locations, providing an annuity like royalty stream with few capital requirements. This stability, coupled with strong unit growth prospects, inroads into the CPG channel, and supply-chain improvements, could drive ROIC excluding goodwill to the low 30s (from the low- to mid-20s today).

Despite our optimism about Dunkin's asset-light business model and long-term growth potential, we believe the global specialty coffee category will see increased competition from existing players as well as breakfast daypart expansion from QSR chains. However, we're optimistic about "Blueprint for Growth" strategies such as an improved beverage/breakfast sandwich pipeline, expanded espresso capabilities, streamlined menu, targeted value offerings (including the "Go2" breakfast sandwich platform), new store configurations, and DD Perks digital marketing/"On the Go" ordering functionality.”

(R.J. Hottovy, strategist)

Dig deeper: What restaurant closures mean for restaurant industry

Walgreens Boots Alliance WBA

“Founded in 1901, Walgreens Boots Alliance is the leading pharmacy retailer leveraging scale to provide convenience. Currently, the company generates nearly US$140 billion in revenue and dispenses over a billion prescriptions annually, representing a quarter of the drug market. The more than 10,000 domestic stores are strategically located in high-traffic areas to generate over US$13 million per store, which drives scale and helps enable the company to negotiate more effectively with suppliers. Scale remains critical in an increasingly competitive market that has witnessed some rationalization of subscale peers. The core business is centred around the pharmacy which accounts for nearly three fourths of revenue and is the main driver of traffic. Management will need to pull through more volume in the recently acquired Rite Aid locations along with stores abroad as reimbursement stabilizes in Europe.

Narrow-moat Walgreens Boots Alliance reported stronger-than-expected second-quarter results that were ahead of our and CapIQ expectations, largely reflecting strength in wholesale, cost-saving initiatives, and share repurchases. These were offset by continued international weakness and reimbursement pressure. Management noted unprecedented traffic during the first 21 days of March, resulting in a revenue increase of about 30 per cent followed by double-digit declines after hoarding of supplies and prescriptions slowed dramatically. To comply with local and federal travel restrictions, internal resources have been reallocated, which will result in US$65 million in incremental expenses that are expected to diminish over time, and internal strategic initiatives have been halted. Also, management pulled fiscal guidance, and we continue to anticipate volatility in the short term. Management will maintain its attractive dividend policy, which will continue to grow with cash flows. We maintain our narrow moat rating, but we have shaved our fair value estimate to US$55 to reflect the delayed realisation of transformation benefits.”

(Soo Romanoff, analyst)

Yum Brands YUM

“Mirroring steps by its peers, wide-moat Yum Brands announced several measures to better navigate coronavirus-related restaurant operating restrictions and changes in consumer behaviour, including a US$525 million drawdown on its revolving credit facility and suspension of its US$2 billion share repurchase program. Following the US$425 million borrowed to complete the acquisition of The Habit Restaurants, the company now has US$950 million drawn on its revolving credit facility (in addition to US$10.6 billion debt on its balance sheet as of December) and more than US$1 billion cash and cash equivalents. The company currently remains in compliance with all credit facility covenants.

Yum also provided additional colour regarding the measures it is adopting to aid franchisees who need greater access to capital, including a grace period for certain near-term payments where necessary (both in the United States and internationally) and allowing franchisees to defer 2020 capital obligations for remodels and new unit builds through the end of the year (US only). While Yum will still have distressed franchisee situations to deal with--including NPC International, which operates more than 1,200 Pizza Hut locations and was already exploring restructuring alternatives before coronavirus-related restrictions were implemented--but we believe these measures will help to minimise possible franchisee disruption in 2020.

From a sales standpoint, management disclosed that first-quarter consolidated comps would experience a mid- to high-single-digit decline and that second-quarter comps would likely see a "more significant" decrease than the first quarter. This is consistent with our current model assumptions (updated March 17) which call for a high-single-digit decline in the first quarter and low- to mid-teens decline in the second quarter, and as such, we're not planning a change to our US$102 fair value estimate and we see shares as undervalued.”

(R.J. Hottovy, strategist)

This article originally appeared on Morningstar.com

is director of content for Morningstar.com.

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