Morningstar.com
Two Stocks with Hefty Expected Returns
Tuesday January 29, 6:00 pm ET
By Alex Morozov, CFA


Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.

Anheuser-Busch Companies
Moat: Wide
Risk: Below Average
Price/Fair Value Ratio*: 0.83
Three-Year Expected Annual Return*: 15.5%

What It Does: Anheuser-Busch (NYSE:BUD - News) is the largest American brewer. Its domestic beer brands, which include Budweiser, Michelob, Busch, and Natural Light, are produced at 12 breweries in the United States. The company owns 50% of Grupo Modelo and has made substantial investments in Chinese breweries. It also owns a brewery in the United Kingdom and licenses its brands to various brewers worldwide. The company owns packaging companies and nine theme parks, including Sea World and Busch Gardens.

What Gives It an Edge: Morningstar analyst Ann Gilpin thinks Anheuser-Busch has a wide economic moat. The firm dominates the domestic beer market with nearly 50% share, and this scale advantage has allowed it to demand exclusivity from about 60% of its distributors, compared with 10% of its peers' volume that is distributed under exclusive arrangements. Anheuser-Busch's infrastructure for the distribution of alcoholic beverages in the U.S. is unparalleled, and the firm should be able to further leverage this system to generate improved growth by branching into faster-growth categories.

What the Risks Are: Because brewers have high fixed costs, weak volume trends significantly deteriorate profits. Wine and spirits have grown in popularity domestically at the expense of beer during the last few years, making each of the oligopolistic U.S. brewers more willing to discount to maintain volume. As a consequence, the domestic beer pricing environment, which was strong for a number of years, has become increasingly competitive.

What the Market Is Missing: Gilpin believes the market is preoccupied with near-term commodity (hops and barley) cost issues affecting all brewers, and it is discounting Anheuser-Busch's brands, unmatched scale, and its history of generating strong cash flows. Gilpin anticipates a more rational domestic pricing environment as the industry consolidates, on the heels of the recent joint venture agreement between SABMiller and Molson Coors (NYSE:TAP - News). Although Gilpin concedes that commodity costs may take a bite out of margins in 2008, she believes Anheuser-Busch will weather the storm and provide its investors with ample returns.

General Mills
Moat: Narrow
Risk: Below Average
Price/Fair Value Ratio*: 0.81
Three-Year Expected Annual Return*: 17.3%

What It Does: General Mills (NYSE:GIS - News) is one of the largest packaged food companies in the United States. It produces ready-to-eat breakfast cereals, refrigerated dough and other baking items, snack and convenience foods, frozen vegetables, yogurt, and beverages. Well-known brands include Cheerios, Lucky Charms, Wheaties, Chex, Betty Crocker, Pillsbury, Gold Medal, Green Giant, Hamburger Helper, Old El Paso, Pop Secret, Colombo, and Yoplait. U.S. sales account for 85% of the firm's annual revenues.

What Gives It an Edge: With its well-known brands, General Mills has significant presence in the grocery aisles. More importantly, the company holds either the number-one or number-two market position in 12 product categories. Such strong brands allow General Mills to acquire favorable shelf space at retail and charge premium prices for its products, producing industry-leading margins and superior returns on invested capital. As a result, Morningstar analyst Greggory Warren has assigned General Mills a narrow moat.

What the Risks Are: General Mills is heavily influenced by the commodity-driven nature of its business. Input cost volatility, as well as the commodification of several of its categories, such as ready-to-eat cereals, has had an impact on profitability. General Mills faces stiff competition from branded and private-label food manufacturers in many of its product lines. Increased volatility in its foodservice segment has also been detrimental to the firm's sales and earnings growth during the last few years.

What the Market Is Missing: Warren thinks most of the packaged food firms have traded down over the past month on growing concerns over commodity cost inflation. However, he counters that the food and beverage manufacturers have in the past been able to pass much of the increase along to customers, either through straight price increases or ingenious alternatives. Although Warren believes the price hikes could negatively impact volume, the effect will differ depending on the product category involved. With below-average private-label penetration in categories such as ready-to-eat cereals (15%) and yogurt, which combined make up more than one third of the company's annual sales, Warren does not see much potential for disruption in General Mills' business. Soup sales are also not likely to be troubled, as the firm's chief competitor, Campbell Soup (NYSE:CPB - News), needs to be rational with its pricing for a category that makes up about half of its sales and profitability.

Other New 5-Star Stocks
Clorox (NYSE:CLX - News)
ConAgra Foods (NYSE:CAG - News)

* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, Jan. 25, 2008.