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How Mergers & Acquisitions Could Boost
March, 28th 2017

Infant formula company Mead Johnson Nutrition Co. (MJN US, +24.60%) benefited from corporate action news shortly after being added to the U.S. Moat Index in December. News of an intended acquisition of MJN US by narrow moat UK conglomerate Reckitt Benckiser Group (RB GB) boosted shares of the company in February. MJN US joins other recent constituents to benefit from acquisition activity: LinkedIn Corp., St. Jude Medical, Inc., and Time Warner, Inc.

Market Realist
Reconstitution benefits index
In December, the Morningstar Wide Moat Focus Index’s (MOAT) portfolio was reconstituted, with 11 stocks (CVS) added and 11 stocks removed. US infant and child nutrition specialist Mead Johnson Nutrition (MJN) was one of the stocks added to the portfolio. MJN was added at a discount to its fair value as calculated by Morningstar, at a price-to-fair value ratio of 0.84.

How Mergers & Acquisitions Could Boost Moat Indexes

Consolidation: A power boost?
In February, British consumer health company Reckitt Benckiser bought Mead Johnson Nutrition (MJN) for $16.6 billion, or $90 per share. In response to the acquisition, MJN stock jumped 24.6%, boosting the Morningstar Wide Moat Focus Index’s overall returns. Likewise, mergers and acquisitions by index constituents provided healthy returns in February. Consolidation in various industries could grant competitive advantages to companies (AXP) (UTX) in the International Moat Index (MOTI), ultimately boosting returns.

It’s been a wild ride for pharmaceutical and biotech companies since last year’s U.S. presidential election, but Morningstar’s economic moat and valuation research within both industries benefited the U.S. Moat Index as several of the top drivers of performance came from within those industries. Materials firm Compass Minerals International (CMP US, -8.47%) struggled for the month and was the leading detractor from U.S. Moat Index performance. CMP US, a producer of road deicing salt, was negative impacted by a notable drop in road salt prices.

Healthcare stocks boost moat indexes
Since the beginning of Donald Trump’s presidency, healthcare stocks have underperformed the benchmark due to negativity towards his policies. Trump aims to bring down the cost of medicine (PPH) by boosting free-market competition, and also supports consumers re-importing drugs from abroad. He is in favor of allowing Medicare to negotiate lower prices for prescription drugs.

Could It Be Time to Buy US Domestic Moats?

Pharmaceutical constituents
As pessimism engulfs the sector, several healthcare companies struggle to generate healthy returns. However, most of the Morningstar Wide Moat Focus Index’s (MOAT) healthcare and biotechnology constituents were top performers in February. Biopharmaceutical company Amgen (AMGN) rose 12.7%, multinational pharmaceutical company Allergan rose 11.8%, Eli Lilly and Company rose 7.5%, Varian Medical Systems (VAR) rose 8%, and Stericycle (SRCL) rose 7.4%. The performance of moat indexes’ healthcare constituents amid the gloominess of the sector demonstrates moat companies’ strength.

Detractors

One laggard was Compass Minerals International, a leading producer of salt, plant nutrients, and magnesium chloride. In 4Q16, the company’s volumes and prices were lower amid higher production costs. Its Salt and Plant Nutrition North America segments’ EBITDA (earnings before interest, tax, depreciation, and amortization) margins narrowed, resulting in stocks underperforming other constituents of the moat index. Other stocks that provided negative returns in February included 21st Century Fox, Gilead Sciences, and Zimmer Biomet.

With the exception of some stocks, most constituents of the US Moat Index generated healthy returns in February, demonstrating the competitive advantage moat indexes (MOTI) have over broader benchmarks.

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