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The Difference Between “Moat” and “Durability”

Thursday, March 2, 2017 14:16
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Someone emailed me this question:

“Am I correct in assuming that when you discuss durability, you are referring to the ongoing need or want for an industry’s products or services, whereas when you discuss moat, you are referring to the competitive positioning of an individual company within its industry?”

Yes. Exactly. Durability is about the product and the product economics of the industry. Moat is the ability of the specific company to sell more of the product and have better product economics than competitors.

In Michael Porter’s approach: moat limits rivalry between firms.

And durability is about the relationship between the customers and the firm we are looking at.

So, Corticeira Amorim (Amorim Cork) in Portugal may have low durability and a wide moat at the same time, because it has advantages in the production and especially the distribution of cork compared to other firms. However, there are substitutes for cork including synthetic products and screw tops. Societal shifts in the acceptance of these ways of enclosing a wine bottle would mean that Amorim might not have very good durability.

On the other hand, a company like McCormick (MKC) has perfect durability. McCormick sells a variety of spices. Spices have been part of the food that even households that aren’t very rich have used for well over 2,000 years and they have been used all over the world. It isn’t anything cultural that determines the desire for spices. The spices used may change a little but people all over the world will always want to add spices to their meals. Whether McCormick will always be a leader in spices is a different question. But, 2,000 years from today people will be spicing the food they eat. I’m not a hundred percent sure people will be corking wine even just 20 years from now.

Sanderson Farms (SAFM) is another good example of the distinction between durability and moat. The durability of chicken is excellent. There are only a handful of domesticated animals that have been as selectively bred and extensively used as meat – mainly cattle and pigs - throughout human history. The product economics of processing chicken are also fine, you can earn a decent ROE doing it. I also think chicken should continue to be a cheaper protein than other alternatives. So, while I can’t guarantee humans will be eating chicken in 2,000 years – I’m sure they’ll be eating about as much or more chicken in 20 years. And I wouldn’t be surprised if people are still eating more chicken than almost any other meat even 50, 100, or 200 years from now. So, I think the durability of SAFM’s product and the business model - the things the firm actually does day-to-day – are both durable in terms of providing value for customers. The question is rivalry between firms. Fifteen years from today, someone will be doing what Sanderson is doing. But, how much profit will the firms that process chicken actually make? That’s why I compare it to airlines. Airlines will be around in 20 years. It’s not hard to guess how many passengers will be flying in 2037 within the United States. It may, however, be hard to know how much the major carriers will make in profit per passenger.

From a discounted cash flow perspective, it isn’t very important what earnings will be far into the future. If you are buying a tradeable, liquid asset like a stock and you are expecting a fairly high return on your money (I try to stay in cash till I find something I expect to compound at 10% a year) you don’t really need to worry about 50 or 100 years. I’d say that the clarity with which you can see the next 5-15 years is what matters. A lot of investors and analysts are looking out at years 1-4. But, if you can find situations where the durability 5-15 years out and the moat 5-15 years out looks good – you’ll do fine. So, from an intrinsic value perspective – I’d say that both McCormick and Sanderson have high enough durability (in spices and chicken) that risks to durability don’t need to factor into your investment analysis at all. I would say that Amorim Cork has enough risks to durability that you should factor those risks to the durability of cork as a product and the cork industry in general into your calculation of the price you’d be willing to pay for Amorim stock.

Here are some examples of how I’d classify durability.

 

ZERO RISK TO DURABILITY (nothing about the product is going to change in the next 15 years)

* Sanderson Farms (SAFM) – Chicken

* McCormick (MKC) – Spices

* Omnicom (OMC) – Advertising

 

SOME RISK TO DURABILITY (something about the product may change in the next 5-15 years)

* Progressive (PGR) – Car insurance

* Corticeira Amorim – Wine corks

* Village Supermarket (VLGEA) – Offline groceries

 

BIG RISK TO DURABILITY (something about the product may change in the next 5 years)

* Fossil (FOSL) – Watches

* Teradata (TDC) – Data warehouses

* Wal-Mart (WMT) – Offline general retail

 

What I said above doesn’t deal with moat. For example, I would put Costco (COST) in the “low durability” category and yet also in the “wide moat” category. Costco has a strong competitive position. However, offline retail has serious risks to durability within even just the next 5 years. On the other hand, there are plenty of commodity type products (like steel) that have high durability as a product and yet no moat at all for many of the individual firms.

I think you can keep this fairly simple.

Durability: Will customers still value this product as much in 5 years, 15 years?

Moat: Will the company’s competitive position versus its rivals be as strong in 5 years, 15 years?

If you aren’t sure about either of these statements over the next 5 years, don’t buy the stock.

If you aren’t sure about either of these statements over the next 5-15 years, you need to seriously consider whether this is the kind of business you want to own and how cheaply you need the stock to be selling for.

If are sure about both of these statements over the next 15 years, you’re fine. To buy Apple (AAPL), you need to be sure of the durability of smartphones generally and the Apple iPhone specifically through 2032. Beyond that, it’s okay if you don’t know what the future will be. But, if you have any uncertainty about the durability of smartphones or the moat around the iPhone between now and 2022 – you really can’t buy the stock. Risks to moat or durability that could manifest themselves within the next 5 years are what cause losses in a stock.

Ask Geoff a question.



Source: http://www.gannononinvesting.com/blog/2017/3/2/the-difference-between-moat-and-durability

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