Morningstar Advisor - April/May 2010 - 65

moat rating, our analysts need to be convinced that the company has a good chance of earning outsized returns on capital for 20 years or more. Only 10% of our coverage universe is high-quality enough to merit this designation, so it’s a select group. (Think Coca-Cola KO or Exxon Mobil XOM.) For a narrow moat rating, a company must stand a good chance— in our view—of earning good returns on capital for 10 years or thereabouts. These are still great companies, even if we don’t have the same degree of confidence that their competitive advantages are sustainable as we do with wide-moat firms.

Symbicort. Collectively, these drugs posted $15 billion in sales for 2008, representing half of sales. Ongoing clinical studies are advancing the indications for these products and tapping into new patient pools for continued growth. Also, the corresponding patent expirations range from 2010 to 2016, which provides ample time for pipeline products to kick in. Modifiedrelease versions of these products may also partially extend patent protection.
Energy Transfer Partners ETP

HPAs tend to have long product lives, stable pricing, and strong profitability. We think Maxim’s HPA expertise and the favorable characteristics of the HPA industry are the source of the firm’s wide economic moat.
Paychex PAYX

And

Financial Health Grade

> B–

Next, we require that the company sport a financial health grade of B or better. The financial health grade is one of the key components of Morningstar’s new corporate credit ratings, and it does a good job of flagging companies with deteriorating financials. If the company has a poor financial health grade, it’s likely to run into trouble maintaining, or even paying, its dividend in future years. The screen yields about 70 stocks. Below, we highlight five of them that our analysts think are particularly attractive.
AstraZeneca AZN

We have long thought that Energy Transfer benefits from two savvy strategic moves. First, full-throttle investment in Barnett Shale takeaway capacity has begun to have an increasing impact on earnings, and second, entry into interstate transportation has broadened Energy Transfer's theater of operations and may widen its economic moat. In our view, Energy Transfer operates one of the best natural gas transportation systems in the industry, and when combined with strong growth prospects, generous cash distributions, and good cash-flow growth visibility, we think this is one of the most attractive master limited partnerships in our coverage.
Maxim Integrated Products MXIM

Switching from one payroll-processing vendor to another is a very difficult task, and customers' unwillingness to do so has allowed Paychex to build a relatively sticky client base. This inelasticity has enabled the firm to raise prices annually and expand profits. Strong scalability has also allowed the firm to be price competitive without feeling margin pressure. Paychex is the secondlargest player in the payroll outsourcing market (based on revenue), and it can leverage its 550,000 clients to spread costs associated with its servicing infrastructure. The firm's strong brand also plays a significant role, because clients are hesitant to entrust their critical HR functions and payroll cash to an unproven competitor. The combination of these factors has produced margins that have been well above 30% during the past 10 years.
Southern Company SO

AstraZeneca's leading presence in the pharma and biotech industry is built on patentprotected drugs and a developing pipeline that all add up to a wide moat. The firm's dynamic operations and an aggressive acquisition strategy create growth opportunities to offset patent losses, including the near-term expiration on cardiovascular drug Toprol. The company boasts a healthy product portfolio led by five key drugs. These growth drivers include gastrointestinal drug Nexium, antipsychotic treatment Seroquel, cholesterol reducer Crestor, and respiratory agent

Maxim is a leading analog chipmaker that made a bold shift in strategy a few years ago by entering high-volume segments of the analog semiconductor market. Although Maxim earns lower gross margins on high-volume chips, it should remain a profitable player for years to come. Maxim has an attractive dividend policy and generates healthy free cash flow on a regular basis. Maxim’s specialty is the design and production of high-performance analog chips, which are used by a wide variety of industries. HPA design expertise is not easy to come by, so firms that have spent years developing proprietary designs and retaining experienced engineers have an advantage over new entrants. These designs do not rapidly evolve or require cutting-edge production techniques, so

We think this well-positioned juggernaut from the Deep South could be an attractive investment for investors seeking dividends and capital preservation. Enviable regulatory relationships and rate structures, along with a commitment to the pure-play regulated utility model, make Southern one of our favorite regulated utilities. The company has paid a stable or increasing dividend for 242 consecutive quarters, yields 4.8% at our fair value estimate, and could raise the dividend by 4% annually.
Haywood Kelly, CFA, is vice president of equity research at Morningstar.

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Morningstar Advisor - April/May 2010

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