The strong stock market rally experienced since early March has evaporated many of the bargains once present, but some still remain. It is not too late to be buying, especially if one is selective in what they purchase. In this report, I highlight 10 âhidden gemsâ you have probably not heard of before that we at Morningstar think look like attractive investment opportunities today.
At Morningstar, we view stocks for what they really areâownership stakes in businesses. As such, we value any given stock like we would value a business, by estimating how much cash that business is expected to generate in the future and valuing it in todayâs terms. This discounted cash flow method is at the foundation of every single fair value estimate in this report.
In coming up with this list of companies, I looked only at companies that had stocks trading at a significant discount to our estimate of its intrinsic value. In each of these cases, the trading discount to our fair value estimate is sufficient enough to give a margin of safety large enough to consider buying the stock.
After getting a list of what we think are the cheapest stocks, I then focused my efforts on the smaller names that may not be well known by the average investor. Each of the companies in this report has a market capitalization of under $4 billion. The market is very often less efficient with smaller companies that have few investors looking at them, coughing up more situations where a stock may be mispriced. Plus, smaller companies can often be easier to understand and analyze. Also consider that as of Aug. 31, 2009, the Russell 2000 index (focused on smaller companies) has easily outperformed the S&P 500 index (focused on larger companies) in not just the year-to-date period, but also for longer five-and 10-year periods. Simply, the action is with small companies.
Since my focus in my newsletter, Morningstar StockInvestor, is on the highest quality companies, I first selected the companies with wide economic moatsâCompass Minerals CMP, Enterprise GP Holdings EPE, IMS Health RX, International Speedway ISCA, and Weight Watchers WTW. These are companies with sustainable competitive advantages that should allow them to generate high returns on invested capital for an extended period of time. Less than 10% of our coverage universe at Morningstar has an economic moat rating of wide, so these firms really are the best of the best.
I then located some of the more interesting firms with narrow economic moatsâMohawk MHK, UTi Worldwide UTIW, Wesco Financial WSC, Wilmington Trust WL. While these companies have businesses that are not quite as attractive as the group above, each still has some sort of economic moat worthy of owning for the long-term.
In StockInvestor I usually do not touch companies with no economic moats, yet the last company I selected for this reportâSunPower SPWRAâis a firm with a number of short-term catalysts in front of it. More importantly, the stock simply does not appear to reflect the cash flow this company should generate. But still, this is the most speculative company in this report.
It is often said that the stock market in the short term is a voting machine, but it is a weighing machine in the long term. I have no idea how the near-term popularity âvotesâ on these stocks will come in, but we at Morningstar do believe the market is under-appreciating the âweightâ of these particular small companies. We think it is worthwhile to read what we have to say, do some of your own research, and then consider buying these stocks.
Compass Minerals CMP
Stock Price (09/10/09): $58.67
Morningstar Fair Value Estimate: $85.00
Profile
Compass Minerals produces salt in North America and the United Kingdom. The company also produces sulfate of potash and magnesium chloride in North America. Compass Mineralsâ products are used for highway deicing, consumer deicing, water conditioning, consumer and industrial food preparation, agriculture, and industrial applications. Nearly half the highway deicing salt used in Compassâ markets (primarily the Great Lakes region) is supplied by this company.
Thesis
Compass Minerals has strong competitive advantages as a result of its world-class rock salt and sulfate of potash, or SOP, resources.
Compassâ major offering is highway deicing salt, so its profitability is determined by cold, snowy, or icy winter weather. The firm also produces salt for consumer and industrial uses, such as water conditioning, livestock feed, food processing, and table salt. Finally, Compass produces SOP, a specialty fertilizer that improves the yield and quality of high-value crops. Compass is expanding its highway deicing salt and SOP production capacity, which should result in profitable sales growth. In addition, SOP prices increased dramatically during the first part of 2008, thanks to strong global demand for fertilizers and tight supply. As the worldâs population grows, the amount of arable land per person decreases. Further, increasing personal income levels in developing countries are driving people to change their diets. Finally, high crude oil prices and political considerations have motivated countries to encourage biofuel production. All of these factors contribute to growing demand for fertilizers.
Compass has a wide economic moat because of its low-cost advantage. Salt is a commodity productâthereâs little differentiation, and industry players compete on price. But Compassâ world-class rock salt mines in Goderich, Ontario; Cote Blanche, La.; and the United Kingdom plus access to water transportation systems give the company the ability to produce and deliver highway deicing salt cost-effectively. Further, Compassâ energy-efficient Great Salt Lake solar evaporation facility gives the firm an edge in the production of SOP. As a result, Compassâ SOP margins have been quite handsome.
We think Compassâ economic moat is quite strong, but there is always the possibility of attacks from either competitorsâ irrational pricing or future viable substitutes for highway deicing salt. For example, Compassâ highway deicing salt competitors could decide to cut prices during one season in order to gain market share and put a financial squeeze on Compass, which has a decent amount of financial leverage. However, as the highway deicing salt industry is oligopolistic, we think thi...
