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5 Names From Our 5 Sources of Moats(7:35)

Elizabeth Collins
Director of Basic Materials Research, Chair of Economic Moat Committee

September 27, 2013
   

MATT COFINA: For Morningstar, I’m Matt Coffina. I’m joined today by Elizabeth Collins, who is the director of our basic materials team and also chairs our economic moat committee. We’re going to talk about how the moat committee works and how Morningstar assigns economic moat ratings to companies.


 

Thanks for joining me, Elizabeth.


ELIZABETH COLLINS: Thanks for having me.


COFINA: First, could you tell us how does the moat committee work, and why is it important to our equity-research process?


COLLINS: On the moat committee, we have a little bit over 15 senior members of the equity research department. And this moat committee meets about two to three times a week, and we vote on analyst proposals for their company’s moat ratings. And basically, the analysts make a case for why they think a company should have a particular moat rating. We ask critical-thinking questions about the company’s competitive advantages. Then the voters cast their votes, and the majority rules.


 

I think it’s important for our equity research methodology because it ensures consistency and rigor, and so that if you’re reading about a moat rating on any particular company, you know that it’s consistently applied across our coverage universe. It's comparable on an apples-to-apples basis no matter what the sector or industry is.


COFFINA: Morningstar has identified five sources of an economic moat. Can you tell me what those are?


 

COLLINS: Sure. We’ve intangible assets, customer switching costs, cost advantages, network effect, and the efficient scale phenomenon.


 

COFFINA: Start with cost advantages. What is that and what’s an example of a company with a cost advantage?


 

COLLINS: Sure. So, a cost advantage, it might be that you’re selling a commodity product or something where there is not an opportunity to differentiate on prices. But if you’re a company [with a cost advantage] you have an advantage because of your ability to sustainably produce the good or service at a cost lower than everybody else. So, you capture that spread between prices that everybody is charging and your costs, which are lower than everybody else’s.


And a good example on this category would be Ultra Petroleum, which is a natural gas producer. Mother Nature gave them very advantaged geological assets that they had for many years, and they produce natural gas at a cost lower than the rest of their peers.


COFFINA: How about intangible assets?


 

COLLINS: So, intangible assets is a category that covers a lot of ground. We have brands, patents, and then government regulations, things of that nature. So, let me talk about brands. Here we’re looking for brands that allow companies to charge a premium price. So a brand, if it just means name recognition, that doesn’t really qualify for an economic moat, but if it allows the company to charge a higher price, then that’s something that might be moat-worthy.


 

And a good example here is Coca-Cola. Unlike some grocery-store items, where people are willing to save money and buy the store brand or generic brand, soda is something where brand really matters and people are less willing to trade down to store brands.


COFFINA: I think one of the strongest sources of an economic moat is the network effect. Can you give me an example of a network effect?


 

COLLINS: I think you are right. The network effect is a very potent form of competitive advantage. I think the best example here is eBay, and with the network affect the value of a good or service increases for both buyers and sellers, as more buyers and sellers are added to the network.


 

So, if you think about it, you want to sell your old Beanie Babies, you are going to go to the platform that has the most potential buyers--bidders [in eBay's case]. And if you're in the market for Beanie Babies, you want to go to the platform that has the most potential sellers of Beanie Babies. And so, the platform becomes stronger as more people get added to the platform.


 

COFFINA: Great. [Can you talk about] switching costs?


 

COLLINS: Switching costs is where several competitors might be offering a similar good or service. But you don't see as much price competition because customers won't switch for small differences in price because the value they gain from getting that lower price would be more than offset by the costs they would have to incur in either time or money in order to undergo the switch.


 

So, in this case, we see examples like Oracle. It has massive database offerings. Companies don't want to undergo the cost of switching providers because it would be huge headaches for them. They lose business, [and it causes] disruption of their business. So, basically there is high cost of failure and low cost of ongoing service. It makes sense to stick with your existing provider.


 

COFFINA: And lastly, I think probably the least intuitive of the sources of moat is efficient scale.


 

COLLINS: Efficient scale is where a limited market is effectively served by one or a small number of existing players. And potential entrants are disincentivized from entering the market because doing so would result in a market share battle, and in order to recoup their costs of investment for entering the industry they’d have to compete a lot on price. Doing so would depress prices for all players, depressing returns for everybody in the industry, and it defeats the purpose of entering in the first place.


 

A good example of an efficient scale phenomenon is pipeline. So, a good example would be Kinder Morgan. It only makes sense to transport a certain amount of oil from point A to point B. Once a pipeline is built that meets that need, it doesn't make any sense to undergo the capital costs in order to build another pipeline.


 

COFFINA: How do we weigh in the moat committee quantitative versus qualitative evidence when assigning a moat rating?


 

COLLINS: I think that they are both equally important. So, we're looking for the qualitative factors, the underlying sources of competitive advantage, the five sources that you and I just talked about. But we also have some quantitative hurdles that we want companies to jump over before we award them a narrow or wide economic moat rating. Our ratings are forward-looking.


 

For a narrow-moat company we're looking for them to have economic profits. In most cases, that means returns on invested capital that are higher than the weighted average cost of capital, that are sustainable for at least 10 years. With a wide-moat company, we want those positive economic profits to be sustainable for at least 20 years. There is also a degree of certainty that we look at. We have a higher degree of certainty with a wide-moat company, and with a narrow moat company even we need to be more likely than not certain that the economic profits will be positive 10 years from now.


 

COFFINA: Well, this has been great. Thanks for joining me, Elizabeth.


 

COLLINS: Thanks for having me.


 

COFFINA: For Morningstar, I'm Matt Coffina


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IMPORTANT DISCLOSURE


The views and opinions expressed are those of Morningstar’s Elizabeth Collins and Matt Coffina and are current as of 5/21/2013. The views and opinions are subject to change with market conditions and do not necessarily reflect the views and opinions of Van Eck Global. The views are provided for informational purposes only, are not meant as investment advice and are subject to change. Van Eck Global cannot guarantee the accuracy or completeness of any statement or data contained in this presentation. Past performance is not a guarantee of future results. All economic and performance information referenced is historical and is no guarantee of future results.


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Hard Assets (12)
LPL Financial Research:US Energy Renaissance Q&A with Van Eck Global(9:56)
Shawn Reynolds
Portfolio Manager, Van Eck Global Hard Assets Investment Team

posted on April 14, 2014


"The U.S. energy renaissance is a remarkable resurgence in oil and gas production here in the United States... It’s up over 50% in the last five years, growing at a steep rate. There’s no other country or region in the world that has grown that fast that quickly in the last 30 or 40 years."


Global Research: Mining in Burkina Faso(4:29)
Joe Foster and Ima Casanova
Senior Gold Analysts

posted on April 10, 2014


"We invest across the spectrum, but in Burkina, it is mostly mid-tier and junior companies that are active. Most of Burkina’s gold deposits are moderate to smaller-sized, so we find smaller companies there. Because of the favorable operating environment, there are quite a few interesting opportunities."


Gold 2014: Investment Demand, Geopolitical Risks, and Corporate Discipline (4:25)
Joe Foster and Ima Casanova
Senior Gold Analysts

posted on April 7, 2014


"Emerging markets geopolitical risks have probably been the main driver of gold this year. People are worried about financial stability with headlines coming from Thailand, Venezuela, Ukraine, and Turkey. People are also concerned about the growth in China and the Chinese banking system."


Gold 2Q 2014: Review of Earnings Results and Costs(4:29)
Joe Foster and Ima Casanova
Senior Gold Analysts

posted on April 3, 2014


"The market focused more on cost and operating results, and did not necessarily punish companies that missed earnings expectations"


Industrial Metals 2Q 2014: Commodity Outlook, Capital Management, and Mine Strikes(5:58)
Charl Malan
Metals & Mining Analyst

posted on April 3, 2014


"We believe that towards the latter part of 2014 capital management, defined as cost management and CAPEX reductions will be a potential significant kicker for higher earnings. It will ultimately develop into a higher rating for metals and mining companies through either a cash flow multiple or an EV/EBITDA multiple."


Agribusiness 2Q 2014: Crop Yield, Pricing, and Precision Farming(5:24)
Sam Halpert
Agriculture Analyst

posted on March 25, 2014


"We're headed toward the U.S. planting season and the USDA has come out with its initial estimates. They predict very good acreage numbers, both in corn and soy. Assuming normal weather, we expect another good crop which should ultimately put some downward pressure on prices."


Gold: Back on Track for 2014?(5:41)
Joe Foster
Senior Gold Analyst

posted on January 21, 2014


“In the near-term, $1200 is an important technical level. The gold market fell to around the $1200 level in June of this year, and we're retesting those lows right now in the wake of the Fed announcement that they will begin tapering in 2014.”


CMCAX: Using the Constant Maturity Approach to Commodities(8:27)
Roland Morris
Commodities Strategist

posted on January 7, 2014


"Amongst the three drivers: commodity exposure, roll exposure, and collateral exposure, CMCAX does a great job of isolating commodity exposure. It does that through its constant maturity approach to reduce the roll risk, does not take collateral risk, and maintains a very short-term Treasury bill-holding which essentially eliminates collateral risk.


Agribusiness: Review of 2013 and Outlook for 2014(6:01)
Sam Halpert
Agriculture Analyst

posted on December 4, 2013


“RFS, which is the Renewable Fuel Standard, will likely be reformed in 2014. There has been a ton of pressure from various constituents on the fuel standard. It's based on assumptions about gasoline demand that are outdated and we think that it will change.”


Industrial Metals: Focusing on Capital and Cost Management in 2014(7:09)
Charl Malan
Metals and Mining Analyst

posted on November 20, 2013


"We've seen many management changes among mining companies over the last year and a half. Many of the top twenty mining companies have changed senior management. Where previous management was focused much more on growth at any cost, new management is focused on capital and cost management... in 2014 [we] are likely to continue to see this aggressive approach by new management on reducing costs."


Current and Future Themes: Unconventional Resources(3:23)
Shawn Reynolds
Portfolio Manager, Van Eck Global Hard Assets Investment Team

posted on October 9, 2013


"We see many opportunities in the Permian Basin, in West Texas, which is divided into two areas: the Midland eastern basin and the Delaware western basin. The Midland Basin is a bit more advanced than the Delaware basin but we have exposure to both regions."


Evolving Themes: Global Mining (4:00)
Shawn Reynolds
Portfolio Manager, Van Eck Global Hard Assets Investment Team

posted on October 9, 2013


"There's been a big paradigm shift in the mining sector over the last year, and we are seeing high-level management changes that reflect this. The industry is shifting from a focus on growth, to one that emphasizes expense reduction, margins, returns, and eventually getting to higher valuations.”


Emerging Markets (15)
EM Debt 2Q 2014: Emerging Markets in Crisis? (4:23)
Fran Rodilosso
Portfolio Manager, Market Vectors® Fixed Income ETFs

posted on April 1, 2014


"The emerging markets are not a single asset class, nor obviously a single country or region. There are pockets that are in a period of crisis… I would be remiss to talk about a potential crisis without discussing China, which has grabbed so many headlines this year."


Fixed Income 2Q 2014: Rates, Credit, and U.S. Corporates(5:00)
Fran Rodilosso
Portfolio Manager, Market Vectors® Fixed Income ETFs

posted on April 1, 2014


"The consensus has been that the risk would be for rates to rise to 4% on the 10 year. But the perspective looking into the second quarter is that we're range-bound on 2.6 to 3%. If that consensus holds that's going to be supportive for a lot of financial markets."


Global Research: Highlights from Eastern Europe(3:52)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on March 11, 2014


"Even though large parts of the region benefit from growth recovery in the euro zone, especially Germany, there are two large economies, Russia and Turkey, where the growth dynamics remain extremely anemic."


Global Research: Poland(3:25)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on March 12, 2014


"I think Poland is uniquely positioned to benefit from Germany's rebound... My key concern about Poland, however, is potential exposure to change in sentiment from political risks in Ukraine."


Global Research: Hungary(4:38)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on March 14, 2014


"The shift in my outlook for Hungary has been fairly dramatic… the government, together with the central bank implemented fairly aggressive and large-scale funding for lending programs but I have yet to see the results in terms of stronger growth in Hungary."


Global Research: Turkey(5:36)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on March 14, 2014


"The macroeconomic fundamentals in Turkey are getting worse. Turkey is vulnerable, but it’s always been vulnerable. It’s never had enough reserves. Its real interest rates have never been that satisfying. But the political context is the worst I’ve seen in twenty years."


Global Research: Romania(3:48)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on March 14, 2014


"My outlook on Romania did not necessarily change for the negative but certain red flags were raised during my trip."


Global Research: Ukraine(4:59)
Eric Fine and Natalia Gurushina
Portfolio Manager and Economist, Van Eck Unconstrained Emerging Markets Bond Investment Team

posted on February 12, 2014


"The scenario of civil war and perhaps a civil war that has broader implications for the region is a scenario we have to think about. It's hard to assign probabilities to that, but the market seems to be saying it's a zero and I think zero is definitely the wrong answer."


Global Fixed Income Investment Themes in 2014(6:35)
Fran Rodilosso
Portfolio Manager, Market Vectors® Fixed Income ETFs

posted on February 21, 2014


"As a fixed-income investor, some key themes for 2014 are not that different from 2013. We believe that it may make sense to shorten duration, and to take on some additional credit risk to make up for the loss of yield by moving to shorter durations appear to makes sense."


2013 Review of Global Fixed-Income Markets(4:37)
Fran Rodilosso
Portfolio Manager, Market Vectors® Fixed Income ETFs

posted on February 21, 2014


"In 2013, improving growth in the U.S. helped short-term interest rates remain low which helped support credit markets in general… European sovereign debt traded quite well last year, as did European credit, particularly high yield, for many of the same reasons that credit did well in the U.S."


How Will Tapering Affect EM Bonds?(4:08)
Eric Fine
Portfolio Manager, Van Eck Unconstrained Emerging Markets Bond Fund

posted on February 19, 2014


“I don't have a blanket answer that says the taper is just not an issue for EM, but I do think it's been priced in generally. I think some countries have been able to react, and if tapering's happening because of good final demand, because economies are growing, then that's a high-quality problem for EM countries.”


Global Research: Indonesia, Malaysia, Philippines, and Vietnam(9:51)
Eric Fine
Portfolio Manager, Van Eck Unconstrained Emerging Markets Bond Fund

posted on February 19, 2014


“A big attraction for Japanese and Korean investments in China is low wages. There are substantial and continuous wage pressures in China and that brings a big challenge for existing investments. The countries that I visited are all seeing substantial interest and in many cases are already seeing inflows from Japan.”


Why Unconstrained Approach to EM Bond Investing?(4:25)
Eric Fine
Portfolio Manager, Van Eck Unconstrained Emerging Markets Bond Fund

posted on February 11, 2014


“In one word, the value of an unconstrained approach to emerging markets bond portfolio investing is ‘flexibility’. The market changed a lot in the past 20 years. At first, it was only hard currency bonds. Then came hard currency corporates followed by local currency sovereigns. Nowadays, local currency corporates are becoming more prominent. Having an unconstrained mandate is key to optimizing the portfolio using all four sub asset classes.”


EM Equities: Middle-Income Trap, Tapering, and Frontier Markets 2014(5:56)
David Semple
Portfolio Manager, Van Eck Emerging Markets Fund

posted on January 24, 2014


“Over time, we think that there will be increasing idiosyncrasies from country to country. Allied to that is the effect of tapering which should sort out which countries are stronger than others. Our thesis last year was to not see emerging markets as a beta block but rather as a collection of countries where we can pick the best stocks.”


EMAG: No Assembly Required(5:14)
Fran Rodilosso
Portfolio Manager, Market Vectors® Fixed Income ETFs

posted on December 10, 2013


“EMAG offers a way for investors to gain broad exposure to emerging markets fixed income, both hard currency and local currency, in their portfolios….EMAG encompasses the broad opportunity set within the emerging markets fixed-income space.”


Editor's Choice (4)
Muni 2Q 2014 Investment Themes (5:06)
Jim Colby
Portfolio Manager, Market Vectors® Municipal Bond ETFs

posted on April 1, 2014


"We have a platform where we believe the Federal Reserve is going to modestly adjust its quantitative easing and provide us with a stable platform going forward with respect to interest rates."


SHYD: Shorten Up for Rising Rates(4:43)
Jim Colby
Portfolio Manager, Market Vectors® Municipal Bond ETFs

posted on February 26, 2014


"One of SHYD's compelling features is that it is uniquely positioned to deal with some of the current problems that investors are facing in today's markets… including rising interest rates."


Israel: Positive Economic Surprises in 2013(5:19)
Steven Schoenfeld
Founder and Chief Invesment Officer,
BlueStar Indexes


posted on January 15, 2014


“There have been positive surprises in the economy, both because of fiscal discipline, greater tax receipts, and the fact that energy exports are starting to come online. We’re very positive on the Israeli economy.”


Israeli Capital Markets: Challenges, Return of Equity Flows, and Opportunities(7:56)
Steven Schoenfeld
Founder and Chief Invesment Officer,
BlueStar Indexes


posted on January 15, 2014


"The research we do at BlueStar looks at both valuations and technical patterns in the market. Even though the BlueStar Israel Global Index has had a very strong rally and could be due for a pause, we expect further highs in 2014.”


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