Are there any ‘moat’ companies in the US?

Warren Buffett once said “A truly great business must have an enduring ‘moat’ that protects excellent returns on investment capital”. Chris Kent, portfolio manager on the Artemis US equity team, explores whether there are currently any ‘moat’ companies in the US.

Chris Kent

The legendary US investor Warren Buffett regularly talks about looking to invest in companies and businesses which have ‘moats’ around them.

‘A truly great business must have an enduring 'moat' that protects excellent returns on invested capital,’ he said.

Over 30 years ago he told a group of students at Notre Dame university: “The most important thing in evaluating businesses is figuring out how big the moat is around the business.”

When evaluating potential investments, we spend a lot of time on properly understanding the competitive environment that the company operates in.

Companies in highly competitive industries with low barriers to entry should struggle to earn attractive returns over the long term: excess returns will be competed away.

The opposite should also hold true.

Companies in less competitive industries with higher barriers to entry should be better positioned to drive long-term returns ahead of their cost of capital.

Often on the Artemis US equities desk, you’ll hear us talking about “moats” as shorthand for the above. The bigger the moat around the business, the better.

Here are three examples of businesses which we’re currently invested in that to our analysis display ‘moat’ characteristics.

Clean Harbors (ticker: CLH, $8.1bn market cap)

Clean Harbors is an environmental services company that specialises in the handling and disposal of hazardous waste. This is a heavily regulated industry and companies need extensive permitting to be able to participate. It would not be easy for a new entrant to quickly gather the permits required.

Reputation is crucial: customers need to be able to trust that their hazardous waste will be disposed of safely and appropriately. Their customers face operational and reputational risk if the waste they generate is not handled properly.

Regulatory challenges, plus a certain amount of NIMBY-ism have resulted in very limited capacity additions. This means it would be extremely difficult for a new competitor to offer a collection-to-incineration service.

Finally, asset ownership is very important. Lots of hazardous waste needs to be incinerated. They own and operate the largest commercial fleet of hazardous waste incinerators. We have also seen captive incinerators (those owned and operated by manufacturing businesses) begin to shut down, further increasing demand for commercial incineration.

Copart (ticker: CPRT, $41.9bn market cap)

Network effects are a different type of moat. Copart operates an auction platform for insurance companies to sell vehicles that have been totaled (written-off).

It has invested extensively over the years to provide a best-in-class service to their insurance customers, and to attract buyers from all over the world onto their platform.

Consequently, insurance sellers enjoy a platform that helps them realise the best price for totalled vehicles (and encourages them to sell more vehicles through the platform), and buyers enjoy a growing pool of carefully inspected vehicles to choose from, all through a platform they trust.

Increasingly we think the company has opportunities to grow in non-insurance end markets, for example rental car fleets, enabled by the robust platform they have built.

Eagle Materials (ticker: EXP, $5.9bn market cap)

Eagle Materials manufactures cement and wallboard. It is very difficult to get environmental permitting to build new cement capacity in the US, and as such supply currently exceeds demand.

It is also not economically viable to ship cement more than 100-150 miles by truck. This means that asset location is extremely important: Eagle’s production footprint is concentrated in the southern US, which continues to see population migration from northern states.

Even in an equity market as large and diverse as the US, we believe it is still possible to find listed companies that exhibit the ‘moat’ characteristics to which Buffett so regularly refers.

Chris Kent is a portfolio manager on the US equity team at Artemis which manages the Artemis US Select Fund and the Artemis US Smaller Companies Fund.

Chris Kent

Manages:

‘US Select’ strategy

Chris co-manages Artemis’ ‘US Select’ strategy

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