Sunday, July 25, 2010

Morningstar ... Hello, hello .... HELLO?

Long-time readers here know that I am a bit of a Morningstar fan, appreciating their truly independent coverage, and an unconflicted (eg investment banking activities) viewpoint, that so tainted any so-called independent research that emanated from the so-called major institutions.

Nevertheless, I have to call them out today. Came across a residential apartment owner, Equity Residential (EQR), to whom they assign a "three-star" rating (average). They estimate the fair value of the shares at just $35 (last traded at one-third OVER than level, at $45). They also say the business has no moat, and say their valuation is subject to high uncertainty (two factors that usually lower their star rating). Furthermore, they estimate the forward PE as 64, and the current price/cash flow as 19.

They also add...

In the near term, Equity Residential's main geographies are suffering from high unemployment, and a deteriorated housing market. All else equal, high unemployment and consequential lower job mobility lowers housing demand, and makes it difficult for landlords to increase rents. Equity Residential's ownership share of a given metropolitan area is, by and large, less than 3%, so it can't readily affect the sector's pricing discipline.
On the positive side, they note that EQR has above-average balance sheet strength, leading to the potential for future residential "trophy" acquisitions. However, they also say ...

While we think this environment will present the firm with more attractive acquisition opportunities, we do not bake unannounced acquisitions into our valuation model ...
The final kick is the closing statement that they think EQR can earn 7% on its capital over the next ten years, LOWER than their estimated cost of capital at 7.9%.

So, let's see if I have this all correctly: overvalued, no moat, trading at high income/cash-flow metrics, weak "same-store" price increase income prospects going forward from existing portfolio, no pricing pricing power in the market, and can't earn its cost of capital.

Jack ... JACK ... assign this one an "average" rating, on the account of the "magic beans" that the CEO has in his pocket.

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