Ten hybrids with economic moats

Photo: Wayne TaylorCompanies with narrow or wide “moats” – Warren Buffett’s term for sustainable competitive advantage – are valued more highly than those without.

Investing in a company with sustainable competitive advantage – what Warren Buffett refers to as “economic moats” – can provide you with the confidence your investment will continue to thrive and grow for many years ahead.

Morningstar uses the concept of moats as a cornerstone of its analytical framework – companies with “narrow” or “wide” moats are valued more highly than those without and require a smaller margin of safety.

Now the investment firm has brought the concepts of moats to the world of hybrid debt securities.

Hybrids are so named because they have features of both debt and equity – they offer a regular interest payment, at higher headline yields than pure corporate debt, but include a mess of clauses around when the note can be bought back by the issuer, have its maturity extended indefinitely, be converted to equity, or have its payments suspended.

Which means these securities are complicated enough without having to worry about whether the issuing company is going to be around in five years, let alone 10 or 20.

“If we have awarded a moat to a business that means we are very comfortable with its cash flow over the next 20 or 30 years,” says Nick Yaxley, a credit analyst who is pioneering research into hybrid securities at Morningstar.

So while that may not be enough by itself to warrant buying a specific hybrid, it’s a good start. Here’s a list of 10 issuers (the four banks plus six others) with moats.

The Big Four ANZ, CBA, Westpac and NAB have “narrow” moats, according to Morningstar. Their dominant market position was only consolidated during the global financial crisis as challengers were snapped up (St George and BankWest being the two biggest) while others exited the market. A government-regulated oligopoly structure, high barriers to entry, scale, access to cheap funding, and strong brands underpin high returns on capital.

APA Group The gas pipeline business is “well-placed for long-term growth in gas demand with an extensive footprint of gas transmission lines,” writes Yaxley.

Goodman Group Listed property trust and industrial real estate investor Goodman Group’s “benefits of scale, intangible assets and long lease terms are unlikely to deteriorate in the foreseeable future,” says Yaxley.

Ramsay Health Care “Ramsay’s narrow moat stems from scale, allowing it to offer the lowest cost of quality healthcare services from private hospitals within Australia.”

Tabcorp The company has a narrow moat thanks to its long-term wagering licence and “the network effect from the totalisator pool” – where all the money from bets is put into a pool, and then that pool is shared by those who picked the winners. The more people in those pools, the more others also want to be in there as the pot gets bigger – the network effect.

Tatts Group Yaxley explains: “Tatts is a unique investment in that it is essentially a monopoly operator of lotteries, under long-term licences, across most of Australia.”

Woolworths The grocery and liquor store chain can lay claim to an “unparalleled” share of our wallets – a fifth of total retail sales. Low cost and the strength of its network of stores lay the foundation for a powerful competitive advantage.


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