10 cheap moat-y Canadian stocks

These stocks have fallen below our fair value estimates – and have a sustainable competitive advantage relative to their peers

Ruth Saldanha 10 March, 2020 | 1:42AM
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Mountain range

The markets opened with a bang Monday morning, as the collapse in oil sent the stocks cratering – both the S&P/TSX Composite in Canada and the S&P 500 in the U.S. hit circuit breakers, suspending trades. When markets reopened, the slide continued.

Many investors feel panicky when they see such market dips, but the best advice is often to do nothing, and stay calm.

“Emotions are the ultimate wrench in the engine of your investment decisions. Staying disciplined as an investor and sticking to your own investment philosophy through times of turbulence will lead to a better outcome than panicking and likely making the wrong decision at the absolute worst time,” says Ian Tam, Morningstar Canada’s director of investment research.

He points out that equity markets have corrected multiple times in the past and they will in the future. “Ensuring your portfolio is aligned closely with your risk tolerance and having a realistic expectation of returns is what you should be thinking about,” he says, adding that if you are already invested in a diversified asset mix you are comfortable with, stick with that and ride it out.

Buying the dip
For investors who have gunpowder and want to deploy though, market dips often offer attractive opportunities to get into names that were previously overvalued. Last week, we highlighted the cheapest stocks in our coverage universe. The list was not for the faint of heart, featuring extremely high risk stocks in sectors like cannabis and energy.

More importantly, most of the stocks had no economic moat. We at Morningstar believe that when looking for stocks, you should look for a margin of safety, cheap valuation, and an economic moat. The Morningstar Economic Moat Rating represents a company's sustainable competitive advantage. A company with an economic moat can fend off competition and earn high returns on capital for many years to come.

Today, let’s take a look at cheap stocks in our coverage universe that also have an economic moat. These stocks are all trading at a discount to our fair value estimate. Here’s a look at some of the cheapest stocks:

Name Morningstar Star Rating Economic Moat Moat Trend Fair Value
Peyto Exploration & Development Corp (PEY) 4 Narrow Stable 0.53
Cameco Corp (CCO) 5 Narrow Positive 0.55
Nutrien Ltd (NTR) 4 Narrow Stable 0.61
Restaurant Brands International (QSR) 4 Narrow Negative 0.78
The Toronto-Dominion Bank (TD) 4 Wide Stable 0.80
Canadian Imperial Bank of Commerce (CM) 4 Narrow Stable 0.80
BRP Inc (DOO) 4 Narrow Stable 0.81
Bank of Montreal (BMO) 4 Narrow Stable 0.82
Enbridge Inc (ENB) 4 Wide Stable 0.82
Shaw Communications Inc Class B (SJR.B) 4 Narrow Negative 0.83

Morningstar Direct Data as of March 8

Two of these names have a ‘wide’ economic moat - The Toronto-Dominion Bank (TD) and Enbridge (ENB). Let’s look at them in some detail.

Toronto-Dominion Bank
Toronto-Dominion is one of the two largest banks in Canada by assets and one of six that collectively hold roughly 90% of the nation's banking deposits. The bank derives approximately 60% of its revenue from Canada and 35% from the United States, with the rest from other countries.

“Toronto-Dominion has done an admirable job of focusing on its Canadian retail operations and growing into number-one or -two market share for most key products in this segment. The bank also has number-two market share for business banking in Canada. With roughly $350 billion in Canadian assets under management, top-three dealer status in Canada, and being the number-one card issuer in Canada, Toronto-Dominion should remain one of the dominant Canadian banks for years to come,” says Morningstar sector analyst Eric Compton.

He attributes TD’s wide moat to its superior market share in the advantageous Canadian banking environment, a better deposit mix, and exposures to moaty nonbank businesses.

“Toronto-Dominion has consistently had one of the lowest percentages of wholesale funding among the major Canadian banks. This has kept funding costs low, leading to consistently better net interest margins, even as credit costs remained well in line with the other Canadian banks. Extra yield from its credit card portfolio has helped as well. It is also one of the dominant investment banks in Canada,” he points out.

The bank also has a significant ownership stake in TD Ameritrade, a narrow-moat-rated

discount brokerage operating out of the U.S., and the third-largest amount of assets under management among the Canadian banks. U.S. retail operations are also strong, earning 13%-15% returns on tangible common equity, with number-one deposit market share in its largest metro area.

“We believe all of these operations combined warrant a wide moat rating,” Compton says.

Enbridge is a Morningstar Best Idea. It is an energy distribution and transportation company in the United States and Canada. It operates crude and natural gas pipelines, including the Canadian Mainline system. It also owns and operates Canada's largest natural gas distribution company.

“The combination of attractive regulated returns, near- and long-term expansion projects that are underpinned with long-term contracts, and a vast, diverse midstream network allows Enbridge to realize efficient scale on its midstream asset economics and to generate sustainable excess ROICs. Regulatory approval on crude expansion projects also prevents competitors from undertaking expansion projects without necessary approval, acting as

an intangible asset for Enbridge on its Mainline operations. As such, we project that the firm will achieve excess returns on capital within five years and conclude that Enbridge possesses an economic moat. Difficulty obtaining regulatory approval on major pipeline

expansions, attractive regulated tolls that exceed the company’s cost of capital, and 20- to 25-year contracts on regional pipelines afford the company a wide economic moat,” says Morningstar sector analyst Joe Gemino.

Enbridge is a rate triple threat, boasting a wide moat, an attractive 6.8% dividend yield, and a cheap valuation.

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About Author

Ruth Saldanha

Ruth Saldanha  is Editorial Manager at Morningstar.ca. Follow her on Twitter @KarishmaRuth.


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