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10 worldwide winners
By Nick Louth | Thu, 04/10/2012 - 09:44
Certain companies have something that competitors just cannot replicate.
It may be crucial patents that protect a particular device, drug or process. It may be a franchise, such as the ownership of a port or airport close to a big city, or it may be the kind of scale and brand that no rival can attempt to match, such as Disney (DIS) or Coca-Cola (KO).
These qualities, that the legendary investor Warren Buffett termed "economic moats", are the defences which allow a business fortress to defend itself, and should be reflected in higher than usual operating margins over an extended period.
Companies with good economic moats should make great investments. However, economic moats alone are not always enough to make that happen. So before we survey the most impregnable global 10, including two British firms, let's take a look at what can undermine those economic ramparts.
First off, impregnability isn’t measured in a day or a week, it is measured in years or decades. Coca-Cola (founded in 1892) has passed that test, but Facebook (FB) has not and isn’t likely to. Facebook may be the pre-eminent social network site, with huge economies of scale deriving from its 900 million users. However, like most technology and internet franchises, Facebook is tied into marketplaces developing at warp speed. This week's cool website is next week's granny group, off-putting to youthful trendsetters. Franchises in slower moving markets are more likely to endure, whether it is the appeal of Cussons (PZC) Imperial Leather soap, or the known quantity of a McDonald's (MCD) burger.
Facebook also illustrates another disadvantage, that network reach doesn’t always equate to profitability, a problem that online retailer Amazon (AMZN) is also encountering. In fact Facebook has been singularly unsuccessful in turning its ubiquity into cash. It most recently failed to capitalise on the smartphone revolution, a realisation reflected in a plunging share price barely three months after flotation.
Brand reputation is another weak point for some companies. It takes decades to build reputation but it can be lost overnight. Standard Chartered (STAN), until recently seen as having the safest business model among all UK-domiciled banks and accorded a premium rating by investors, has lost its lustre following a scathing regulatory attack from New York. Settling accusations of sanctions busting with Iran has cost it $340 million (£200 million) and that is unlikely to be the end of the matter.
Pharmaceutical companies, likewise, should be impregnable given the 20-year exclusivity on their drug discoveries bestowed by law. Trouble is, it often takes a dozen years of that to get the compound to market, where its revenues have to pay for all the drug candidates that failed, or weren’t as safe, effective or cheap as existing medicines. That's a bar that gets higher every year, as the pool of existing cheap generic medicines expands.
Even an enduring impregnability doesn't guarantee that a company is a great investment. Many listed football clubs, exemplified by Manchester United (MANU), have huge brands, and a loyal following among fans around the globe, who willingly change their expensive replica kits on demand. However, while clubs are good at fleecing fans, the drawbridges are definitely down when it comes to the playing talent. Top players steal away the bulk of industry rewards for their fancy footwork, with salaries in the hundreds of thousands per week. When an industry cannot control its costs, it is no longer impregnable.
The most impregnable global 10
What follows are 10 companies that exhibit some fairly powerful economic moats, though few are entirely impregnable. They are not necessarily a list of 'buy' tips based on current value, more an attempt to pin down the nature of what constitutes an enduring business advantage. Investors that can recognise impregnability in a company may be best to seize on newcomers that have their own economic moats before others realise.
The ownership of a clutch of must-read legal, tax, finance and health journals has powered this Dutch company's growth for decades. This content has grown from being purely print to electronic and online, with value-added analytics in the mix. If one of the measures of business franchise strength is customers' complete reliance on the product, then Wolters Kluwer has what it takes.
Though the company’s growth has been a little more pedestrian in recent years than in the 1990s, it is still a very sound defensive investment, hardly expensive, and one that pays a 5% dividend yield.
Britain's Genus (GNS) is the world leader in genetically improving the quality of livestock. That may have started with the bull semen that was for years its biggest product, but the firm has moved way beyond it.
The company has grown on the back of booming global meat consumption which in turn is driven by increasing incomes, particularly in Asia. With the rising cost of animal feed, and other farm inputs, farmers realise that the best way to boost the value of their meat is to boost the quality of their livestock.
Being spread across pig, beef and dairy markets has allowed it to smooth its profit growth. The company really doesn’t have many direct competitors, and is spread over 70 global geographic markets.
You may never have heard of it, but Italy's Luxottica has as strong a grip on the market for spectacles as Apple has for tablet computers.
Talk about impressive vertical integration: it is the owner of Ray-Ban, and the manufacturer under licence of Chanel, Prada, Versace and a dozen other designer brands; as well as the owner of three of the biggest US spectacle retailers, Sunglass Hut, LensCrafters and Pearle Vision.
If you've ever wondered why decent frames cost so much, the top to bottom grip of this one firm is much of the answer. The shares aren’t any cheaper than the specs, but for brand dominance this one is hard to beat.
There's really nothing to match a Porsche. The iconic German sports cars were once the preserve of city traders on bonus binges, but the rise of Asian wealth has created a whole new breed of buyers, many of whom are drawn to the Panamera and Cayenne SUV, the latest top-selling models.
However, while this is a vehicle for the open road, the company's attractions are snarled in financial gridlock until the complexities of the merger with Volkswagen (VKW) are resolved. While VW is still a great company, it perhaps doesn’t have the cachet that standalone Porsche did. Until there is a clearer picture, this is one to admire from the sidelines.
The British satellite broadcaster has proved that viewers would rather go hungry in recession than miss their live Premier League football action. With a virtual lock-in for the bulk of games, BSkyB (BSY) is well-placed to use its enormous economies of scale to pitch its bid for TV rights higher than rivals.
Though competitors such as BT (BT.A) were willing to push the company on price in recent auctions for football rights, the satellite broadcaster has the deepest pockets. This one has scale, durability and franchise ramparts, and since the fallout from the Leveson Inquiry kicked News Corp's bid hopes into touch, it really isn’t expensive either.
Totally dominant as an internet retailer, Jeff Bezos's creation has spawned dozens of marketplaces from second-hand books to author self-publishing. The sheer convenience of Amazon (AMZN) shopping has changed lives, and the stock price has soared - but all without the company really making much money.
The firm is now moving into social gaming, a market dominated by Zynga (ZNGA) and Facebook, and analysts are already betting that its unique effect of cutting prices will chop margins across the market. So while Amazon has most of the economic moats that an investor would like to see, its determination to go for market share above margins means it is a phenomenon more to wow the consumer than the investor.
The king of internet auctions, eBay's (EBAY) ownership of online transaction system PayPal puts an additional profitable lock on probably the most powerful network effect in commerce today. Unlike Facebook, it has managed to navigate the move from fixed screens to smartphone applications with some grace, and is now expected to make $10 billion of mobile-based transactions this year.
It has managed an annual 25% increase in earnings over the past five years, and is well placed to continue that for the foreseeable future.
The emperor of the internet search, Google (GOOG) has made a reality of its mission to organise the world's information, and reaped billions in advertising dollars off the back of it. Though the core of its success is the search engine, the Android operating system is now imbedding the company deep into the world of mobile phones and other devices, helped by the takeover of Motorola.
Google has risen 620% since listing in 2004, while the S&P 500 has been flat. The price/earnings ratio of 21 may look expensive, but compared to earnings growth that has averaged 26% a year, it really isn't so demanding.
Coca-Cola has turned sugared water into a ubiquitous global brand. Its aim was to make Coke no more than an arm's reach away in every market from Monte Carlo and Manhattan to Brazil's favelas and South Africa’s shanty towns, and it has succeeded.
Investors pay a bit of a premium for Coca-Cola as a share, just as you do for Coke as a product. The drink's price helps keep operating margins at an industry-leading 22%. Perhaps the biggest disappointment is a poor dividend yield of 2.6%.
Innovation is the core of the firm, from the iconic computers that first made the company's name, to the iPods, iPhones and iPads that have made Apple (AAPL) the ultimate in technological cool.
Annual earnings growth has averaged 60% for more than five years. Strip out the $117 billion of cash on the balance sheet (enough to buy HSBC (HSBA) outright), the adjusted prospective price/earnings ratio for next year is a miserly 10.
The main worries are how far it can go in increasing its value and can it defy the rise of less-cool but much cheaper rivals in the mobile devices marketplace.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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