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About the Editor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios invested in accordance with a strategy that seeks to focus on companies with stable or growing competitive advantages. David served in several senior research and product development roles and was part of the editorial team that created and launched Morningstar.com. He was the co-inventor of Morningstar's first investment advice software.

David joined Morningstar in 1994. He holds a bachelor's degree in biology from Skidmore College and a master's degree in biology from the University of Illinois at Springfield.

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Matthew Coffina, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Hare strategy. Matt was previously a senior healthcare analyst, covering managed care and pharmaceutical services companies. Matt also developed the discounted cash flow model used by Morningstar analysts to assign fair value estimates to most of the companies in its global coverage universe.

Matt joined Morningstar in 2007. He holds a bachelor's degree in economics from Oberlin College and also holds the Chartered Financial Analyst (CFA) designation.

Michael Corty, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Tortoise strategy. Before focusing his attention on the Tortoise, Michael co-managed five equity strategies offered by Morningstar Investment Management LLC and Morningstar Investment Services LLC since December 2013. Michael was previously a senior equity analyst on Morningstar Inc.’s equity research team covering companies in the media, business services, and consumer industries. Michael also spent several years on Morningstar’s moat committee, which assigns economic moat and moat trend ratings to their global coverage.

Prior to joining Morningstar in 2004, Michael worked at a public accounting firm and in the business lending arm of a major commercial bank. He has an undergraduate accounting degree from Loyola Marymount University, an MBA from Cornell University and is a CFA charterholder.

About the Editor David Photo
David Harrell
Editor, Morningstar StockInvestor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios
Featured Posts
Roundup 5/29/20 -- Fair Value Increases for Home Depot and Lowe's

StockInvestorSM focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, which manages other client portfolios using these strategies.

Please see new analyst notes and updates below from Morningstar Research Services for Alphabet GOOG/GOOGL, Home Depot HD, and Lowe's LOW.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

Removing the Outperforming and Wide-Moat Alphabet from Our Best Ideas List
by Ali Mogharabi | Morningstar Research Services LLC | 05-28-20

We are removing Alphabet from our Best Ideas list as the stock is now trading slightly above our $1,400 fair value estimate. Alphabet's share price has increased 20% since it was added to the list in April, outperforming the Morningstar U.S. Market Index and the S&P 500, which were up 16% and 14%, respectively.

The firm's first-quarter results (released on April 28) demonstrated that revenue diversification is paying off as solid growth in YouTube and cloud lessened the COVID-19 impact on overall revenue. Also in April, management saw that user behavior was changing slightly, possibly tilting a bit back toward more consumption, which may help ad revenue. However, we think such potential upside is now priced in. There's a lot of uncertainty about whether the change in behavior will strengthen and continue throughout the second quarter and/or the rest of 2020. In addition, advertisers may remain hesitant and reduce ad spending until they see further indications of an economic turnaround. Long-term catalysts for the stock still include the return of strong subscription and ad revenue growth in YouTube, and further traction gained by the firm in the cloud market. Waymo and Verily are essentially call options that represent more upside to our fair value estimate.

Lastly, in terms of risks, in addition to COVID-19's impact on ad spending, Alphabet faces antitrust and regulatory pressures. With the 2020 elections in sight, politicians, federal agencies, and international lawmakers have begun to investigate Alphabet, proposing more stringent enforcement of antitrust laws and calling for changes to or reinterpretation of existing statutes. President Trump's May 28 signing of an executive order, which may lead to less liability protection (provided by Section 230) for Google and some of its peers, is the latest example.

Boosting Home Depot's Fair Value
by Jaime M. Katz, CFA | Morningstar Research Services LLC | 05-26-20

We are increasing our fair value estimate for Home Depot HD to $184 from $179 per share after updating our 2020 forecast, which now includes an operating margin estimate of 13.2% versus 14.0% prior. However, we have adjusted our comp forecast up to 4.9% from 3.5%, leading to total revenue growth of more than 5% (versus 3.7% prior), as the firm continues to benefit from its essential business status. This implies a 2020 price/earnings ratio of 19 times and an EV/EBITDA multiple of 13 times.

Given the maturity of the domestic home improvement industry, we expect demand to depend on changes in the real estate market, driven by prices, interest rates, turnover, and lending standards. We project that sales can grow 4% over the next five years, supported by 3.6% average same-store sales increases and helped by offerings like buy online/pickup in-store and better merchandising, which drives market share gains. Longer term, we forecast gross margins to expand modestly over the next decade (by 40 basis points from 2019 levels, to 34.5%) while the selling, general, and administrative expense ratio leverages by 90 basis points (to 17%) and the firm continues to capitalize on its scale and supply chain improvement initiatives. This leads to a terminal operating margin of 16%, higher than the 14.4% achieved in 2019.

We believe Home Depot's operating margins and ROICs could improve as the firm focuses on improvements in speed and efficiency in the supply chain, and the opportunity to better penetrate the pro business with market delivery centers that leverage its delivery capabilities. Additionally, we think Home Depot still has other opportunities to expand the business. It can capitalize on product lines with weak market share leaders--for example, Sears had been a strong operator in appliances, but as the brand deteriorated (ultimately declaring bankruptcy and embarking on massive store closures), Home Depot was able to steal share. Also, having deeper product lines to cross-sell (with brands like the Company Store offering exposure to textiles) could add incremental revenue potential, with some protection from online competitors such as Amazon, particularly in the maintenance, repair, and operations business. Additionally, the service business backed by a major national brand, as in the acquisition of the commercial business coming from Interline, could build brand loyalty and keep consumers returning to a trusted source, something that could be hard to duplicate by a new entrant.

Increasing Our Value Estimate for Lowe's
by Jaime M. Katz, CFA | Morningstar Research Services LLC | 05-26-20

We are increasing our fair value estimate for Lowe's LOW to $111 per share from $102 after incorporating first-quarter results into our model. This included stellar 11% comp growth (better than the mid-single-digit comps we expected) and more than 200 basis points of operating margin improvement as the company capitalized on its essential retailing status. Our medium-term outlook incorporates improvements to the supply chain, inventory management, and technology, bolstered by further investment in those categories. Our fair value estimate implies a 2020 price/earnings ratio of 16 times and an enterprise value/EBITDA multiple of 11 times.

Post COVID-19, when demand normalizes, we expect throughput for home improvement products should depend mostly on changes in the real estate market, which are driven primarily by prices, interest rates, and turnover, given the maturity of the industry. We expect sales to grow at a low-single-digit pace (3%) over the long term, supported by low-single-digit same-store sales (7% in 2020 and averaging about 2.7% over the next decade) and moderate location growth (netting 10 boxes per year after 2020), as household formations rise. We have long-term gross margins expanding 150 basis points from 31.8% in 2019, to around 33%, while the selling, general, and administrative expense ratio leverages 120 basis points (from 21% in 2019) as upcoming investments roll off but Lowe's continues to spend to protect its competitive position. This leads to operating margins that reach about 12% over our forecast. Lowe's has an operating margin goal of 12% longer term, but we forecast a 10% margin in 2020 as profit improvement ensues slowly as Lowe's rights the ship. We project a 20% average adjusted ROIC, excluding goodwill, over the next five years versus our 8% cost of capital estimate, supporting a wide economic moat.

Lowe's profitability could benefit from institutionalizing processes that were inefficient, including labor management, reset efforts, and inventory controls, all which could squeeze meaningful operating margin expansion out of the business if they are implemented properly. Lowe's still has opportunities to increase revenue from categories like appliances, a category with previously weak market share leaders--Sears' leadership, for example, has declined. Having additional product lines to cross-sell adds incremental sales potential without a tremendous threat from an online competitor; shipping and returns are troublesome at best.


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Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. Analyst ratings are subjective in nature and should not be used as the sole basis for investment decisions. Analyst ratings are based on Morningstar’s analysts’ current expectations about future events and therefore involve unknown risks and uncertainties that may cause such expectations not to occur or to differ significantly from what was expected. Analyst ratings are not guarantees nor should they be viewed as an assessment of a stock's creditworthiness. Ratings, analysis, and other analyst thoughts are provided for informational purposes only; references to securities should not be considered an offer or solicitation to buy or sell the securities.

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Disclosure:
The commentary, analysis, references to, and performance information contained within Morningstar® StockInvestorSM, except where explicitly noted, reflects that of portfolios owned by Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies managed by Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc. References to "Morningstar" refer to Morningstar, Inc.

Opinions expressed are as of the current date and are subject to change without notice. Morningstar, Inc. and Morningstar Investment Management LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only and has not been tailored to suit any individual.

The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless. Securities in this report are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information. Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

Common stocks are typically subject to greater fluctuations in market value than other asset classes as a result of factors such as a company's business performance,
investor perceptions, stock market trends and general economic conditions.

All Morningstar Stock Analyst Notes were published by Morningstar, Inc. The Weekly Roundup contains all Analyst Notes that relate to holdings in Morningstar, Inc.'s Tortoise and Hare Portfolios. Morningstar's analysts are employed by Morningstar, Inc. or its subsidiaries. In the United States, that subsidiary is Morningstar Research Services LLC, which is registered with and governed by the U.S. Securities and Exchange Commission.

David Harrell may own stocks from the Tortoise and Hare Portfolios in his personal accounts.

 
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