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  • Moat Investing

    Aspen Leads, Western Union Lags in Moat Index

    Brandon Rakszawski, Senior ETF Product Manager
    November 08, 2021
     

    Fresh off of its worst performing month of 2021 (September, -4.65%), the S&P 500 Index posted its best monthly return in October to finish the month at 7.01%. The S&P 500 Index also finished the month at an all-time high, fueled by earnings strength and surging large cap growth stocks. Driven largely by stock selection and to a lesser degree its growth underweight, the Morningstar® Wide Moat Focus IndexSM (the “Moat Index” or “Index”) lagged the S&P 500 Index with a 3.69% return in October.

    The Index’ lack of exposure to Tesla (narrow moat rating) and underweight to Microsoft were two of the leading drivers of Index underperformance in October. However, its overweight to several stocks drove the majority of its underperformance. The following are a few of those companies along with several bright spots.

    October Laggards Ticker October Return October Leaders Ticker October Return
    The Western Union Co. WU -9.89% Aspen Technology Inc. AZPN 27.60%
    Polaris Inc. PII -3.94% Tyler Technologies Inc. TYL 18.44%
    Intel Corp INTC -8.03% Merck & Co Inc. MRK 17.23%
    Gilead Sciences Inc. GILD -7.12% Intercontinental Exchange Inc. ICE 20.59%

    Source: Morningstar. Data as of 10/31/2021. Past performance is no guarantee of future results. Individual company and index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com.

    Moat Index: October Laggards

    The Western Union Co. (WU)

    Moat Sources: Cost Advantages; Intangible Assets
    Morningstar Valuation: 30% Discount
    October Total Return: -9.89%

    • Western Union benefits from cost advantages stemming from its scale and produces approximately twice the operating margins of its most profitable competitor, according to Morningstar. Its business model relies heavily on those from developing markets searching for better economic opportunities in the developed world and transferring money home. Despite Western Union’s dominant market position, Morningstar does recognize the early stages of a potential sea change in the money transfer business and continues to monitor the company’s economic moat.

    “The biggest potential threat to Western Union's moat is a shift to alternative methods of transferring money. If these methods were to transform the industry, we could be forced to revisit our wide moat rating. In our opinion, these methods will grow in time to represent a meaningful part of the industry, but are unlikely to have a material impact on Western Union's competitive position for the foreseeable future. A nearer-term issue is an industry shift toward transactions funded by bank accounts and credit or debit cards, but Western Union has been investing heavily in these areas, and we believe it has positioned itself to maintain its overall share as these methods grow in importance.” Brett Horn, Senior Equity Analyst, Morningstar.

    • Western Union’s fair value estimate has remained in the $20 - $26 range since late 2012 and currently stands at the top end at $26 per share. This reflects economic recovery assumptions in 2021 but also a more tepid industry backdrop which may moderate growth potential over Morningstar’s projection period.

    Polaris Inc. (PII)

    Moat Sources: Intangible Assets; Cost Advantages
    Morningstar Valuation: 34% Discount
    October Total Return: -3.94%

    • Polaris was most recently added to the Moat Index in June 2021 following an increase to its fair value estimate from $113 per share to $173. Morningstar has since reduced its fair value estimate to $172 per share, reflecting their assumption that supply chain issues may hinder throughout at least the end of 2021.
    • Polaris has lagged the market since its addition in June, but Morningstar believes it has taken the right steps to protect its wide moat rating (despite nearly non-existent customer switching costs) with disciplined quality assurance protocols and well-developed manufacturing processes to prevent pervasive product recalls.

    Intel Corp. (INTC)

    Moat Sources: Cost Advantages; Intangible Assets
    Morningstar Valuation: 25% Discount
    October Total Return: -8.03%

    • Intel shares fell in late October following the release of third quarter results reflecting revenue below guidance, driven in large part by shipping and supply constraints and underwhelming margin outlook. Morningstar maintained its $65 per share fair value estimate, citing 2022 as their expected near-term trough for margins. That leaves shares undervalued and attractive for long-term, patient investors, according to Morningstar.
    • Morningstar notes that Intel has experienced a renaissance in the PC market as pandemic-related shutdowns have increased the number of PCs per household as more people have been working and learning from home. They also note that Intel is seeing increased pressure from competitor AMD and other market forces that are worth monitoring over the long-term. Morningstar has maintained its fair value estimate of $81 per share since February, leaving shares attractively priced.

    Gilead Sciences (GILD)

    Moat Sources: Intangible Assets
    Morningstar Valuation: 20% Discount
    October Total Return: -7.12%

    • As a leader in HIV and hepatitis treatment, Gilead’s wide moat rating stems from its patent protection and impressive research and development program, which form the basis of its intangible assets source of economic moat. According to Morningstar, Gilead serves 80% of treated HIV patients. Its third quarter results were headlined by higher than expected sales of COVID-19 treatment, Veklury. However, its sales excluding Veklury were down 3%, causing pressure on Gilead shares to end the month.
    • The pandemic has generally resulted in lower HIV diagnosis rates, which has put pressure on the drug manufacturer. Longer term, Morningstar expects improving HIV market dynamics, the launch of novel HIV therapy lenacapavir, and a growing oncology portfolio to help drive stronger growth for Gilead, supporting the firm's wide moat.

    Moat Index Leaders for October

    Aspen Technology Inc. (AZPN)

    Moat Sources: Switching Costs; Intangible Assets
    Morningstar Valuation: 2% Discount
    October Total Return: 27.60%

    • Aspen Technology has been in the Moat Index since entering for the first time in June 2020. It has contributed positively to Index returns throughout that time and particularly in October after reporting quarterly results that exceeded expectations at the end of the month. Aspen has seen its fair value estimate increase several times in the last two years, most recently at the end of October when it increased from $151 per share to $160, reflecting an enterprise value/EBITDA of 18.2. The action followed Emerson Electric’s bid to merge select software businesses with Aspen.
    • Aspen Technology supplies software solutions for complex industrial environments. According to Morningstar, it benefits primarily from high customer switching costs leading to exceptional customer renewal rates. Aspen now trades near its fair value.

    Tyler Technologies Inc. (TYL)

    Moat Sources: Switching Costs; Intangible Assets
    Morningstar Valuation: 6% Discount
    October Total Return: 18.44%

    • Tyler Technologies is a software provider entrenched with cities, counties, schools, courts and other municipal entities. Morningstar indicates that Tyler’s high customer switching costs in a slow-moving and underserved niche market powers its wide moat rating.
    • Morningstar recently increased Tyler’s fair value estimate from $500 to $575 per share based on refinements to its discounted cash flow model after Tyler’s strong third quarter and continued signs of an end market rebound. It continues to see modest upside for Tyler shares.

    Merck & Co. Inc. (MRK)

    Moat Sources: Intangible Assets
    Morningstar Valuation: 6% Discount
    October Total Return: 17.23%

    • Patent protection, a type of intangible assets, forms the bedrock of Merck’s wide moat, according to Morningstar. That drives significant cash flow that affords the drug maker a powerful sales force that acts as (1) a deterrent to developing drug companies seeking to launch competing products and (2) an integral partner for marketing externally developed drugs. Morningstar also notes that Merck’s cash flow also supports the massive R&D costs required to bring each new drug to market.
    • Merck posted strong share performance in October on the heels of third quarter results that were ahead of Morningstar expectations fueled, in part, by irregular vaccine orders. These results reaffirmed Morningstar’s view that the market has underappreciated Merck’s position in immune-oncology and vaccines. Its fair value estimate remained intact at $94 per share following the quarterly results and shares finished the month nearing fair value.

    Intercontinental Exchange (ICE)

    Moat Sources: Cost Advantages; Intangible Assets
    Morningstar Valuation: 10% Premium
    October Total Return: 20.59%

    • ICE entered the Moat Index in June 2021 for the first time since 2014. It has traded at a premium to fair value for the better part of the seven years since but presented a valuation opportunity for a short period over the summer despite a general positive trend for its share price in recent years. October was a strong month for ICE’s share price, capped by strong third quarter results announced at month’s end. ICE’s mortgage technology segment was a standout performer in the quarter. At this rate, ICE may not remain in the Index following the December review.
    • ICE earns its wide moat rating primarily from its exchange business, both futures and the NYSE, as opposed to its data and mortgage tech units. Significant cost advantages exist in their futures exchange, making it ICE’s profit center. The NYSE brand also commands a premium when it comes to selling its data.

    Source of all data: Morningstar. As of October 31, 2021.

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  • Authored by

    Brandon Rakszawski
    Senior ETF Product Manager

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