U.S. Mid Cap Pick List July 2020 This pick list highlights constituents of the Morningstar US Mid Cap Index that we believe offer investors the best risk-adjusted return prospects. Because the list is intended to be a source of idea generation rather than a model portfolio, the number of picks we make in each sector reflects our coverage count in that sector rather than our view as to whether the sector offers relatively greater or fewer buying opportunities. The number of picks in each sector is recalibrated annually to reflect substantial changes in our coverage and our respective benchmark. The Morningstar US Mid Cap Index appreciated by 2.22% in June, closing the month at 15,821. From a bottom-up perspective, the market appears fully valued. The average stock in the Morningstar US Mid Cap Index traded at a 2% premium to our fair value estimate, up from a price/fair value of 1 at the end of May. the median stock trading at an 18% premium to our fair value estimate. The typical energy stock offered the greatest discount, priced at a 26% discount to our fair value estimate. As of June 30, the median constituent of the U.S. Mid Cap Pick List traded at a 35% discount to our fair value estimate. Constituents from the energy sector are the cheapest, in our opinion, priced at a median 57% discount to our fair value estimate. Daniel Rohr, CFA Head of Global Equity Research Jeffrey Stafford, CFA Director of Equity Research, North America Patrick Dunn Director of Global Research Operations This month, Schlumberger was added to the energy list and is priced at a 62% discount to our fair value estimate, offering the greatest discount across this month’s pick list. The healthcare sector ranked as the most expensive, with U.S. Mid Cap Picks Company Ticker Industry Exchange/ Currency Market Cap (Mil) Morningstar Rating Economic Moat Uncertainty Rating Fair Value Estimate Price Price/Fair Value CF Agricultural Inputs XNYS\USD 6016 QQQQQ None High 52.00 28.14 0.54 ALB Specialty Chemicals XNYS\USD 8209 QQQQ Narrow High 125.00 77.21 0.62 E MGM Resorts International MGM Resorts & Casinos XNYS\USD 8286 QQQQQ E WestRock WRK Packaging & Containers XNYS\USD None High 32.00 16.80 0.53 7327 QQQQQ None High 49.00 28.26 0.58 E BorgWarner BWA Auto Parts E Expedia Group EXPE Travel Services XNYS\USD 7318 QQQQQ Narrow High 60.00 35.30 0.59 XNAS\USD 11589 QQQQQ Narrow High 138.00 82.20 0.60 E Wynn Resorts WYNN E LKQ LKQ Resorts & Casinos XNAS\USD 8035 QQQQ Narrow High 112.00 74.49 0.67 Auto Parts XNAS\USD 7964 QQQQ Narrow Medium 35.00 26.20 0.75 E Pilgrims Pride PPC Packaged Foods XNAS\USD 4167 QQQQQ None High 34.50 16.89 0.49 TAP Beverages - Brewers XNYS\USD 7499 QQQQQ E Molson Coors Beverage None Medium 55.00 34.36 0.62 E Schlumberger SLB Oil & Gas Equipment & Services XNYS\USD 25522 QQQQQ Narrow High 48.00 18.39 0.38 E Diamondback Energy FANG Oil & Gas E&P XNAS\USD 6600 QQQQQ Narrow High 87.00 41.82 0.48 AIG Insurance - Diversified XNYS\USD 26855 QQQQQ None High 59.00 31.18 0.53 FITB Banks - Regional XNAS\USD 13726 QQQQ None High 32.00 19.28 0.60 Alexion Pharmaceuticals ALXN Biotechnology XNAS\USD 24786 QQQQ Narrow High 155.00 112.24 0.72 Zimmer Biomet Holdings ZBH Medical Devices XNYS\USD 24684 QQQQ Wide Medium 164.00 119.36 0.73 LH Diagnostics & Research XNYS\USD 16146 QQQQ Narrow Medium 192.00 166.11 0.87 Basic Materials CF Industries Holdings E Albemarle Consumer Cyclical Consumer Defensive Energy Financial Services E American International Group Fifth Third Bancorp Healthcare E Laboratory of America Holdings Data as of June 30, 2020. | ] = Upgrade, [ = Downgrade, E= Addition Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 U.S. Mid Cap Picks Company Ticker Industry Exchange/ Currency E Delta Air Lines DAL Airlines XNYS\USD E Carrier Global CARR Building Products & Equipment E Johnson Controls International JCI URI E Simon Property Group Regency Centers Market Cap (Mil) Morningstar Rating Economic Moat Uncertainty Rating Fair Value Estimate Price Price/Fair Value 17890 QQQQ None XNYS\USD 19246 QQQQ Narrow Very High 43.50 28.05 0.64 High 32.00 22.22 Engineering & Construction XNYS\USD 25395 QQQQ 0.69 Narrow High Rental & Leasing Services XNYS\USD 10738 QQQQ None High 45.00 34.14 0.76 177.00 149.04 0.84 SPG REIT - Retail XNYS\USD 20908 QQQQQ None High 152.00 68.38 0.45 REG REIT - Retail XNAS\USD 7784 QQQQQ None Medium 75.00 45.89 0.61 Lyft LYFT Software - Application XNAS\USD 10128 QQQQ Narrow Very High 50.00 33.01 0.66 Sensata Technologies Holding ST Scientific & Technical Instruments XNYS\USD 5851 Hewlett Packard Enterprise HPE Communication Equipment XNYS\USD 12501 QQQQ Narrow High 50.00 37.23 0.74 QQQQ None High 13.00 9.73 0.75 E Palo Alto Networks PANW Software - Infrastructure XNYS\USD 22155 QQQQ Narrow High 305.00 229.67 0.75 XNYS\USD 64894 QQQQ E VMware VMW Software - Infrastructure Narrow High 202.00 154.86 0.77 AES Utilities - Diversified XNYS\USD 9635 QQQQQ None Medium 20.00 14.49 0.72 Utilities - Regulated Electric XNYS\USD 8245 QQQQ PNW Narrow Low 89.00 73.29 0.82 Industrials United Rentals Real Estate Technology Utilities AES E Pinnacle West Capital Data as of June 30, 2020. | ] = Upgrade, [ = Downgrade, E= Addition ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 2 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 New Picks Commentary Basic Materials Albemarle | Seth Goldstein, CFA Bulls Say • Albemarle has top-tier lithium assets through its brine operations in Chile and spodumene hard-rock operations in Western Australia, which are among the lowest-cost sources of lithium production globally. • The company has tremendous upside to electric vehicle growth through lithium batteries. Its Talison joint venture is one of the few large operations that can significantly ramp up production over the next few years to meet incremental demand. • Albemarle also has low-cost bromine production through its highly concentrated brines in the Dead Sea and Arkansas. Bears Say • Lithium prices will fall as new supply comes online faster than demand, which will weigh on profitability. Albemarle's plans to increase its lithium production capacity will prove value destructive in the wake of lower prices. • Albemarle's bromine business will decline from weaker demand for flame retardants, its primary end market, as consumers shift from desktops and laptops to less bromine-intensive tablets and mobile phones. • Lower oil prices will lead oil refiners to hold off on replacing their hydroprocessing catalysts, which need to be replaced once every one to three years. Consumer Cyclical MGM Resorts International | Dan Wasiolek Bulls Say • We expect MGM to be awarded a Japanese gaming concession due to its strong experience operating leading resorts in Las Vegas and also its successful record of working with partners. • MGM is positioned to participate in Macau's long-term growth opportunity (21% of 2019 EBITDAR) and has seen its room share expand (to 8% from 3%) with the opening of its Cotai casino in February 2018. • MGM has entered into a sale-leaseback deal for its Bellagio, Circus Circus, and MGM Grand, freeing funds to shore up its balance sheet and for financing a Japanese resort. Bears Say • The majority of cash flow for the company comes from the mature Las Vegas region, which has lower barriers, margins, and ROICs than Macau. • The Macau and Chinese governments are transitioning the region's mix toward a nongaming full resort destination site, which could place outsize pressure on growth for MGM, given its relatively low nongaming mix. • The unknown duration and extent of the coronavirus stands to have a material impact on leisure and travel demand. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 3 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Consumer Defensive Pilgrim's Pride | Rebecca Scheuneman, CFA Bulls Say • Margins in the U.S. should improve as the demand for U.S. proteins improves in the wake of China's African swine fever outbreak and the elimination of China's ban on imports of U.S. poultry. • Pilgrim’s has an opportunity to unlock value through structurally boosting the profits of its European operations by applying best practices from the U.S. and Mexico and using its key customer strategy to change the producer/ customer dynamic. • Production disruptions in beef and pork have driven prices higher, and we think some consumption will shift to chicken. Bears Say • The majority of the company’s products are undifferentiated, making it difficult for Pilgrim's to command a price premium and sustain high returns. • Thin margins coupled with difficult-to-control external business impacts make it difficult to report consistent profits, as exhibited by the company’s 2008 bankruptcy. • Class-action litigation against the company alleging price-fixing activities could absorb significant management attention. Energy Schlumberger | Preston Caldwell Bulls Say • Schlumberger has long spent more on R&D than all its service company peers combined and more than all the oil majors. • The company has a multi-decade track record of innovation and a proven ability to generate shareholder value in even dismal oil market conditions. • Schlumberger Production Management is a hidden gem within the company, likely to generate growth with high returns on capital in years to come. Bears Say • Schlumberger’s comparative lack of focus on U.S. shale will hobble its long-term revenue growth, given the likely preponderance of U.S. shale as a share of future incremental oil supply. • The company’s expensive acquisition of Cameron in 2016 demonstrated a lack of discipline, which investors should be wary of repeating. • Baker Hughes’ gambit to merge with GE has the chance to level the playing field with Schlumberger in terms of new product development. Financial Services American International Group | Brett Horn, CFA Bulls Say • The aftermath of AIG's issues during the financial crisis occupied much of management's attention for quite some time. With these issues resolved, management can focus on the company's operations, and there could be ample scope for improvement. • AIG has demonstrated progress in improving underwriting margins in its P&C business. • The current focus on risk-adjusted returns sets a proper course for the company, and just increasing profitability to the level of its peers would represent a material improvement. Bears Say • AIG has a history of under-reserving for claims, making it difficult to trust that current reserves are adequate. • AIG has yet to prove that its existing franchise can earn adequate returns. • As a diversified player in an industry that is not particularly moaty, AIG will always be dealing with issues in some part of its business. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 4 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Healthcare Laboratory Corp. of America Holdings | Debbie S. Wang Bulls Say • The uncertainty around LabCorp's exclusive contract with UnitedHealth has dissipated and the new nonexclusive relationship will help LabCorp navigate payment reforms. • The more complex and labor-intensive esoteric tests are reimbursed at a higher rate and often outsourced by hospitals to independent labs. LabCorp is funneling resources to broaden its menu of complex esoteric tests, which should help maintain its healthy margin. • LabCorp has been able to keep less profitable capitated managed-care contracts to a minimum, accounting for only 4.3% of 2019 diagnostic revenue. Bears Say • If significant numbers of hospital-based labs are illequipped to comply with Medicare's payment reporting requirements, then reimbursement pressure could increase even more in the 2023-24 time frame. • LabCorp needs the analytics expertise of Covance, which would be diminished if LabCorp cannot retain former Covance employees. • It could take longer than anticipated for bundled payments to become the norm for providers, in which case increased volume and the ensuing operating leverage could be more than five years off. Industrials Delta Air Lines| Brian Bernard, CFA, CPA Bulls Say • Delta should be able to extract value from its international joint ventures, enabling it to access Asian, Latin American, and European markets more effectively than peers. • Delta’s strategy of operating an older fleet keeps a lid on depreciation expenses and capital expenditures and aligns well with the current era of low fuel prices. • Management will defend the carrier's passenger revenue per available seat mile premium, enabling the company to achieve best-in-class margins among network carriers. Bears Say • It could take years for Delta to recover from the economic carnage caused by COVID-19, and the virus could lead to changed consumer behavior that would be unfavorable for the airline industry (for example, video conferences replace business travel). • Delta’s PRASM premium could be competed away as peers like Southwest offer premium product options to customers, other network carriers roll out basic economy, and LCCs enter the Atlantic market. • Delta and other U.S. carriers could continue to bid away their profits, pushing fares down and depressing margins. Real Estate Simon Property Group | Kevin Brown Bulls Say • Simon's access to capital, scale, and validated record position the firm to execute on any attractive and available investment opportunities. • Simon's high-quality portfolio will continue to present attractive locations for tenants to place stores even as retail companies look to reduce store counts and present the most desirable locations for e-tailers looking to establish a physical presence. • Simon’s mall and outlet portfolio contains a high percentage of the best malls in the country where redevelopment capital can be deployed at the most promising yields. Bears Say • If consumers forced to purchase goods online during the coronavirus crisis permanently change their behavior to favor e-commerce and avoid public places, then longterm sales growth could suffer. • Retailers are looking to reduce store counts and average store size, so Simon may need to make significant concessions to keep existing tenants and attract new tenants to fill both in-line and anchor spaces. • Given the relative maturity of the U.S. retail market and the size of the company, Simon may be encouraged to seek larger, riskier investments domestically and abroad to move the needle. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 5 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Technology Palo Alto Networks | Mark Cash Bulls Say • Adding on modules to its security platform could win greenfield opportunities and increase spending from existing customers. • Palo Alto could showcase great operating margin leverage as it moves from brand creation and into a perennial cybersecurity leader. Winning bids should be less costly as the incumbent and we think Palo Alto is typically on the shortlist of potential vendors. • The company is segueing into high-growth areas to supplement its firewall leadership. Analytics and machine learning capabilities could separate Palo Alto's offerings. Bears Say • The large public cloud vendors are developing security suites that may be preferred over those of a pure-play security supplier. If these companies offer products outside their data centers, Palo Alto may be stuck with niche applications and on-premises products. • Palo Alto competitors are also offering consolidated platforms, which could make displacing competitors more challenging. • Cloud and software-based startups could disrupt Palo Alto's high growth plans. The market for acquiring bolt-on firms could be hotly contested, and Palo Alto could miss out on the next big technology. Utilities Pinnacle West Capital | Charles Fishman, CFA Bulls Say • We expect annual dividend increases to average 6% from 2021-2024. • Arizona's population growth has historically been higher than the U.S. average, driving rate base growth with investments in generation, transmission, and distribution. • Following the negative impact of COVID-19, we have a fairly high level of confidence management will achieve its targeted 9.5% ROE or higher, driving earnings and dividend growth for the foreseeable future. Bears Say • Utility regulation in Arizona has a history of political influence, subjecting regulatory decisions to uncertainty and raising risk for shareholders. • A focus on energy efficiency by Arizona regulators and incentives for rooftop solar systems has reduced electricity sales growth for APS, even though customer growth is expected to be higher than typical U.S. utilities. • Customers with rooftop solar systems pay less than their actual cost of service. However, solar customers and installers have been very public in attacking regulator against any changes to rates. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 6 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Pick List Deletions Company Ticker Industry Exchange/ Currency Market Cap (Mil) Morningstar Rating Economic Moat Uncertainty Rating Fair Value Estimate Price Price/Fair Value Mosaic MOS Agricultural Inputs American Airlines Group AAL Airlines XNYS\USD 4582 QQQQQ None XNAS\USD 4440 QQQQ None Very High 30.00 12.09 0.40 Very High 15.70 10.50 0.67 PVH PVH Hanesbrands HBI Apparel Manufacturing XNYS\USD 3226 QQQQQ None High Apparel Manufacturing XNYS\USD 3432 QQQQQ Narrow Medium 108.00 45.47 0.42 23.00 9.86 0.43 Gap Discover Financial Services GPS Apparel Retail XNYS\USD 3316 QQQQQ None High DFS Credit Services XNYS\USD 14552 QQQQQ Narrow High 22.50 8.90 0.40 82.00 47.51 0.58 Nordstrom JWN Department Stores XNYS\USD 2532 QQQQQ Narrow Kohl's KSS Department Stores XNYS\USD 2984 QQQQQ None High 37.00 16.13 0.44 High 42.00 19.22 0.46 US Foods Holding USFD Food Distribution XNYS\USD 4216 QQQQQ Centene CNC Healthcare Plans XNYS\USD 38367 QQQQ None Medium 31.00 19.14 0.62 Narrow High 85.00 66.25 0.78 2770 QQQQQ Coty COTY Household & Personal Products XNYS\USD HD Supply Holdings HDS Industrial Distribution XNAS\USD None High 6.50 3.63 0.56 5137 QQQQQ Narrow Medium 46.00 31.71 0.69 XNAS\USD 1920 QQQQQ Sabre SABR Information Technology Services Xerox Holdings XRX Information Technology Services Narrow Very High 17.50 6.97 0.40 XNYS\USD 3381 QQQQ None High 26.00 15.88 0.61 Luxury Goods XNYS\USD 3755 QQQQQ Tapestry TPR Noble Energy NBL Narrow High 35.00 13.60 0.39 Oil & Gas E&P XNAS\USD 4188 QQQQQ None High 20.00 8.73 0.44 HAL Oil & Gas Equipment & Services XNYS\USD 10308 QQQQQ Halliburton Kimco Realty Narrow High 26.00 11.75 0.45 KIM REIT - Retail XNYS\USD 4805 QQQQQ None Medium 20.00 11.11 0.56 Howmet Aerospace HWM Specialty Industrial Machinery XNYS\USD 5704 QQQQ None Very High 18.50 13.08 0.71 CenterPoint Energy CNP Utilities - Regulated Gas XNYS\USD 8937 QQQQ Narrow Medium 24.00 17.78 0.74 Data as of June 30, 2020. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 7 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Research Methodology for Valuing Companies Four key components drive the Morningstar rating: (1) our assessment of the firm’s economic moat, (2) our estimate of the stock’s fair value, (3) our uncertainty around that fair value estimate and (4) the current market price. This process ultimately culminates in our single-point star rating. Overview Economic Moat At the heart of our valuation system is a detailed projection of a company’s future cash flows, resulting from our analysts’ research. Analysts create custom industry and company assumptions to feed income statement, balance sheet, and capital investment assumptions into our globally standardized, proprietary discounted cash flow, or DCF, modeling templates. We use scenario analysis, in-depth competitive advantage analysis, and a variety of other analytical tools to augment this process. Moreover, we think analyzing valuation through discounted cash flows presents a better lens for viewing cyclical companies, high-growth firms, businesses with finite lives (e.g., mines), or companies expected to generate negative earnings over the next few years. That said, we don’t dismiss multiples altogether but rather use them as supporting cross-checks for our DCFbased fair value estimates. We also acknowledge that DCF models offer their own challenges (including a potential proliferation of estimated inputs and the possibility that the method may miss short-term market-price movements), but we believe these negatives are mitigated by deep analysis and our long-term approach. The concept of an economic moat plays a vital role not only in our qualitative assessment of a firm’s long-term investment potential, but also in the actual calculation of our fair value estimates. An economic moat is a structural feature that allows a firm to sustain excess profits over a long period of time. We define economic profits as returns on invested capital (or ROIC) over and above our estimate of a firm’s cost of capital, or weighted average cost of capital (or WACC). Without a moat, profits are more susceptible to competition. We have identified five sources of economic moats: intangible assets, switching costs, network effect, cost advantage, and efficient scale. Morningstar’s equity research group (we”, “our”) believes that a company’s intrinsic worth results from the future cash flows it can generate. The Morningstar Rating for stocks identifies stocks trading at a discount or premium to their intrinsic worth—or fair value estimate, in Morningstar terminology. Five-star stocks sell for the biggest risk-adjusted discount to their fair values, whereas 1-star stocks trade at premiums to their intrinsic worth. Companies with a narrow moat are those we believe are more likely than not to achieve normalized excess returns for at least the next 10 years. Wide-moat companies are those in which we have very high confidence that excess returns will remain for 10 years, with excess returns more likely than not to remain for at least 20 years. The longer a firm generates economic profits, the higher its intrinsic value. We believe low-quality, no-moat companies will see their normalized returns gravitate toward the firm’s cost of capital more quickly than companies with moats. To assess the sustainability of excess profits, analysts perform ongoing assessments of the moat trend. A firm’s moat trend is positive in cases where we think its sources of competitive advantage are growing stronger; stable where we don’t anticipate changes to competitive advantages over the next several years; or negative when we see signs of Morningstar Equity Research Star Rating Methodology Economic Moat Stewardship Financial Health Moat Trend Fundamental Analysis Morningstar Fair Value Valuation Price Fair Value Uncertainty Morningstar RatingTM For Stocks QQQQQ Margin of Safety ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 8 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 deterioration. Estimated Fair Value Combining our analysts’ financial forecasts with the firm’s economic moat helps us assess how long returns on invested capital are likely to exceed the firm’s cost of capital. Returns of firms with a wide economic moat rating are assumed to fade to the perpetuity period over a longer period of time than the returns of narrow-moat firms, and both will fade slower than no-moat firms, increasing our estimate of their intrinsic value. Our model is divided into three distinct stages: Stage I: Explicit Forecast In this stage, which can last five to 10 years, analysts make full financial statement forecasts, including items such as revenue, profit margins, tax rates, changes in working-capital accounts, and capital spending. Based on these projections, we calculate earnings before interest, after taxes (EBI) and the net new investment (NNI) to derive our annual free cash flow forecast. Stage II: Fade The second stage of our model is the period it will take the company’s return on new invested capital—the return on capital of the next dollar invested (“RONIC”)—to decline (or rise) to its cost of capital. During the Stage II period, we use a formula to approximate cash flows in lieu of explicitly modeling the income statement, balance sheet, and cash flow statement as we do in Stage I. The length of the second stage depends on the strength of the company’s economic moat. We forecast this period to last anywhere from one year (for companies with no economic moat) to 10–15 years or more (for wide-moat companies). During this period, cash flows are forecast using four assumptions: an average growth rate for EBI over the period, a normalized investment rate, average return on new invested capital (RONIC), and the number of years until perpetuity, when excess returns cease. The investment rate and return on new invested capital decline until a perpetuity value is calculated. In the case of firms that do not earn their cost of capital, we assume marginal ROICs rise to the firm’s cost of capital (usually attributable to less reinvestment), and we may truncate the second stage. formula. At perpetuity, we assume that any growth or decline or investment in the business neither creates nor destroys value and that any new investment provides a return in line with estimated WACC. Because a dollar earned today is worth more than a dollar earned tomorrow, we discount our projections of cash flows in stages I, II, and III to arrive at a total present value of expected future cash flows. Because we are modeling free cash flow to the firm—representing cash available to provide a return to all capital providers—we discount future cash flows using the WACC, which is a weighted average of the costs of equity, debt, and preferred stock (and any other funding sources), using expected future proportionate longterm, market-value weights. Uncertainty around that fair value estimate Morningstar’s Uncertainty Rating captures a range of likely potential intrinsic values for a company and uses it to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating represents the analysts’ ability to bound the estimated value of the shares in a company around the Fair Value Estimate, based on the characteristics of the business underlying the stock, including operating and financial leverage, sales sensitivity to the overall economy, product concentration, pricing power, and other company-specific factors. Analysts consider at least two scenarios in addition to their base case: a bull case and a bear case. Assumptions are chosen such that the analyst believes there is a 25% probability that the company will perform better than the bull case, and a 25% probability that the company will perform worse than the bear case. The distance between the bull and bear cases is an important indicator of the uncertainty underlying the fair value estimate. Our recommended margin of safety widens as our uncertainty of the estimated value of the equity increases. The more uncertain we are about the estimated value of the equity, the greater the discount we require relative to our estimate of the value of the firm before we would recommend the purchase of the shares. In addition, the uncertainty rating provides guidance in portfolio construction based on risk tolerance. Stage III: Perpetuity Once a company’s marginal ROIC hits its cost of capital, we calculate a continuing value, using a standard perpetuity ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 9 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Our uncertainty ratings for our qualitative analysis are low, medium, high, very high, and extreme. × Medium–margin of safety for 5-star rating is a compare it with the stock’s current market price on a daily basis, and the star rating is automatically re-calculated at the market close on every day the market on which the stock is listed is open. Our analysts keep close tabs on the companies they follow, and, based on thorough and ongoing analysis, raise or lower their fair value estimates as warranted. 30% discount and for 1-star rating is 35% premium. × High–margin of safety for 5-star rating is a 40% discount and for 1-star rating is 55% premium. × Very High–margin of safety for 5-star rating is a 50% discount and for 1-star rating is 75% premium. × Extreme–margin of safety for 5-star rating is a 75% discount and for 1-star rating is 300% premium. Please note, there is no predefined distribution of stars. That is, the percentage of stocks that earn 5 stars can fluctuate daily, so the star ratings, in the aggregate, can serve as a gauge of the broader market’s valuation. When there are many 5-star stocks, the stock market as a whole is more undervalued, in our opinion, than when very few companies × Low–margin of safety for 5-star rating is a 20% discount and for 1-star rating is 25% premium. Morningstar Equity Research Star Rating Methodology 4.5 4.5 4.0 4.0 Q QQ QQQ QQQQ QQQQQ 400% 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 200% 175% 155% 1.5 1.5 135% 125% Price/Fair Value 1.0 1.0 95% 105% 80% 90% 70% 125% 115% 110% 85% 80% 60% 0.5 0.5 50% 50% 25% 0.0 0.0 Low Uncertainty Medium Uncertainty High Uncertainty Very High Uncertainty Extreme Uncertainty garner our highest rating. Market Price The market prices used in this analysis and noted in the report come from exchange on which the stock is listed which we believe is a reliable source. For more details about our methodology, please go to www.global.morningstar.com/equitydisclousures. Morningstar Star Rating for Stocks Once we determine the fair value estimate of a stock, we We expect that if our base-case assumptions are true the market price will converge on our fair value estimate over time, generally within three years (although it is impossible to predict the exact time frame in which market prices may adjust). Our star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, tax situation, time horizon, income needs, and complete investment portfolio, among other factors. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 10 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 The Morningstar Star Ratings for stocks are defined below: QQQQQ We believe appreciation beyond a fair riskadjusted return is highly likely over a multiyear time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential. QQQQ We believe appreciation beyond a fair riskadjusted return is likely. This report is for informational purposes only and has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This publication is intended to provide information to assist institutional investors in making their own investment decisions, not to provide investment advice to any specific investor. Therefore, investments discussed and recommendations made herein may not be suitable for all investors: recipients must exercise their own independent judgment as to the suitability of such investments and recommendations in the light of their own investment objectives, experience, taxation status and financial position. QQQ Indicates our belief that investors are likely to receive a fair risk-adjusted return (approximately cost of equity). QQ We believe investors are likely to receive a less than fair risk-adjusted return. Q Indicates a high probability of undesirable risk-adjusted returns from the current market price over a multiyear time frame, based on our analysis. Scenario analysis by our analysts indicates that the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to Capital loss. Risk Warning Please note that investments in securities are subject to market and other risks and there is no assurance or guarantee that the intended investment objectives will be achieved. Past performance of a security may or may not be sustained in future and is no indication of future performance. A security investment return and an investor’s principal value will fluctuate so that, when redeemed, an investor’s shares may be worth more or less than their original cost. A security’s current investment performance may be lower or higher than the investment performance noted within the report. Morningstar’s Uncertainty Rating serves as a useful data point with respect to sensitivity analysis of the assumptions used in our determining a fair value price. The information, data, analyses and opinions presented herein are not warranted to be accurate, correct, complete or timely. Unless otherwise provided in a separate agreement, neither Morningstar, Inc. or the Equity Research Group represents that the report contents meet all of the presentation and/or disclosure standards applicable in the jurisdiction the recipient is located. Except as otherwise required by law or provided for in a separate agreement, the analyst, Morningstar, Inc. and the Equity Research Group and their officers, directors and employees shall not be responsible or liable for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions within the report. The Equity Research Group encourages recipients of this report to read all relevant issue documents (e.g., prospectus) pertaining to the security concerned, including without limitation, information relevant to its investment objectives, risks, and costs before making an investment decision and when deemed necessary, to seek the advice of a legal, tax, and/or accounting professional. The Report and its contents are not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Morningstar, Inc. or its affiliates to any registration or licensing requirements in such jurisdiction. General Disclosure Unless otherwise provided in a separate agreement, recipients accessing this report may only use it in the country in which the Morningstar distributor is based. Unless stated otherwise, the original distributor of the report is Morningstar Research Services LLC, a U.S.A. domiciled financial institution. Where this report is made available in a language other than English and in the case of inconsistencies between the English and translated versions of the report, the English version will control and supersede any ambiguities associated with any part or section of a report that has been issued in a foreign language. Neither the analyst, ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 11 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 Morningstar, Inc., or the Equity Research Group guarantees the accuracy of the translations. This report may be distributed in certain localities, countries and/or jurisdictions (“Territories”) by independent third parties or independent intermediaries and/or distributors (“Distributors”). Such Distributors are not acting as agents or representatives of the analyst, Morningstar, Inc. or the Equity Research Group. In Territories where a Distributor distributes our report, the Distributor is solely responsible for complying with all applicable regulations, laws, rules, circulars, codes and guidelines established by local and/or regional regulatory bodies, including laws in connection with the distribution third-party research reports. Conflicts of Interest × No interests are held by the analyst with respect to the security subject of this investment research report. × Morningstar, Inc. may hold a long position in the security subject of this investment research report that exceeds 0.5% of the total issued share capital of the security. To determine if such is the case, please click http://msi.morningstar.com and http://mdi.morningstar.com. arrangements nor allow employees from the investment management group to participate or influence the analysis or opinion prepared by them. × Morningstar, Inc. is a publicly traded company (Ticker Symbol: MORN) and thus a financial institution the security of which is the subject of this report may own more than 5% of Morningstar, Inc.’s total outstanding shares. Please access Morningstar, Inc.’s proxy statement, “Security Ownership of Certain Beneficial Owners and Management” section http://investorrelations. morningstar.com/sec.cfm?doctype=Proxy&year=&x=12 × Morningstar, Inc. may provide the product issuer or its related entities with services or products for a fee and on an arms’ length basis including software products and licenses, research and consulting services, data services, licenses to republish our ratings and research in their promotional material, event sponsorship and website advertising. Further information on Morningstar, Inc.’s conflict of interest policies is available from http://global.morningstar.com/ equitydisclosures. Also, please note analysts are subject to the CFA Institute’s Code of Ethics and Standards of Professional Conduct. × Analysts’ compensation is derived from Morningstar, Inc.’s overall earnings and consists of salary, bonus and in some cases restricted stock. × Neither Morningstar, Inc. or the Equity Research Group receives commissions for providing research nor do they charge companies to be rated. × Neither Morningstar, Inc. or the Equity Research Group is a market maker or a liquidity provider of the security noted within this report. × Neither Morningstar, Inc. or the Equity Research Group has been a lead manager or co-lead manager over the previous 12-months of any publicly disclosed offer of financial instruments of the issuer. × Morningstar, Inc.’s investment management group does have arrangements with financial institutions to provide portfolio management/investment advice some of which an analyst may issue investment research reports on. However, analysts do not have authority over Morningstar’s investment management group’s business For a list of securities which the Equity Research Group currently covers and provides written analysis on please contact your local Morningstar office. In addition, for historical analysis of securities covered, including their fair value estimate, please contact your local office. For Recipients in Australia: This Report has been issued and distributed in Australia by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544; ASFL: 240892). Morningstar Australasia Pty Ltd is the provider of the general advice (‘the Service’) and takes responsibility for the production of this report. The Service is provided through the research of investment products. To the extent the Report contains general advice it has been prepared without reference to an investor’s objectives, financial situation or needs. Investors should consider the advice in light of these matters and, if applicable, the relevant Product Disclosure Statement before making any decision to invest. Refer to our Financial Services Guide (FSG) for more information at http://www.morningstar. com.au/fsg.pdf. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 12 Morningstar Equity Research | U.S. Mid Cap Pick List | July 2020 For recipients in Canada: This research is not prepared subject to Canadian disclosure requirements. For Recipients in Hong Kong: The report is distributed by Morningstar Investment Management Asia Limited, which is regulated by the Hong Kong Securities and Futures Commission to provide services to professional investors only. Neither Morningstar Investment Management Asia Limited, nor its representatives, are acting or will be deemed to be acting as an investment advisor to any recipients of this information unless expressly agreed to by Morningstar Investment Management Asia Limited. For enquiries regarding this research, please contact a Morningstar Investment Management Asia Limited Licensed Representative at http://global.morningstar.com/ equitydisclosures. For recipients in Japan: The report is distributed by Ibbotson Associates Japan, Inc., which is regulated by Financial Services Agency. Neither Ibbotson Associates Japan, Inc., nor its representatives, are acting or will be deemed to be acting as an investment advisor to any recipients of this information. 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In India, Morningstar Investment Adviser India Private Limited has one associate, Morningstar India Private Limited, which provides data related services, financial data analysis and software development. The Research Analyst has not served as an officer, director or employee of the fund company within the last 12 months, nor has it or its associates engaged in market making activity for the fund company. *The Conflicts of Interest disclosure above also applies to relatives and associates of Manager Research Analysts in India # The Conflicts of Interest disclosure above also applies to associates of Manager Research Analysts in India. The terms and conditions on which Morningstar Investment Adviser India Private Limited offers Investment Research to clients, varies from client to client, and are detailed in the respective client agreement. ©2020 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. Please see important disclosures at the end of this report. 13
