Everyone knows that market concentration leads to less competition and in turn to more powerful entities within this group. Such oligopolies by definition should allow the respective companies to achieving strong results and high margins due to pricing power, but also where applicable economies of scale. In reality, however, not every sector or company offers automatically a good stock investment, even when factually operating in an oligopoly.

Summary and key takeaways from today’s Weekly
– Oligopolies sound like smart investments as market shares are high and competition is limited.
– So at least the theory. Practically, this does not protect the companies from sector-wide events or the business cycle.
– Before every investment, due diligence is required.

One of my first articles when I started this blog was about monopolies and why Warren Buffett likes them (see here).

At the time of writing, I could only spot one true monopoly among his stock holdings which was Verisign (ISIN: US92343E1029, Ticker: VRSN). This is the company which holds the rights of all .com, .net, .gov and other domains (but not all available domains). Hence, I am also a customer without having a choice.

Even though I didn’t go a step further, many of Buffett’s stock holdings have strong market positions while operating in not so competitive environments.

My main point was that monopolies are not bad per se and that there are even areas where monopolies are a natural occurrence. Otherwise, investing in and sustaining double structures of for example water utilities or railroads would more likely result in higher costs for consumers. A certain degree of regulation is unavoidable, but governments should not try to steer the business.

On the other hand, monopolies like for example Standard Oil or American Tobacco were broken up without hurting consumers. Too high a market concentration can lead to abuse of power.

Interestingly, this only counts on an enterprise level, but not in government… But that’s not today’s topic.

Oligolopies represent markets with high concentration and not just of one dominant entity (monopoly), but of a few ones with high market shares.

This can either be due to natural occurrence or because a once highly fragmented market consolidated itself over time through acquisitions or bankruptcies.

Today, I want to go a bit further and have a look at several oligopolies from the perspective of whether such entire sectors are long-term no-brainer-like buy and hold investments as the companies within these sectors have little competition and high market shares.

The logical thought would be that such companies due to lack of serious competition should be very lucrative investments.

Is this really the case?

Let’s find out.

Join me and my members on our journey to beat the markets!

Good and bad oligopolies for stock investors

When researching and preparing for this Weekly, I made a list of oligopolies I am aware of.

My first thoughts were telecoms and credit cards.

And this the short answer to today’s question whether investing in oligopolies is a no-brainer strategy. No, it is definitely not, because… it depends!

With this one-one tie, I decided to make two lists of “bad” and “good” oligopolies, from the perspective of a shareholder. Then, my goal was to question the reasons for why there are even good and bad investment oligopolies to begin with.

In order not to make this weekly explode, I only briefly commented on each, so this alone by no means makes for an exhaustive research. Also with my categorization, I looked more at each sector as a whole, not necessarily at companies specifically.

Let’s start with the bad ones where I have difficulties in finding attractive stock investments for my members – though, it is not impossible or excluded, however, it heavily depends on each case, as my requirements have to be met.

Oligopolies with rather unattractive sectors include among others:

Aviation industry – airplane producers

Airbus (ISIN: NL0000235190, Ticker: AIR) and Boeing (ISIN: US0970231058, Ticker: BA), with the latter being the topic of a recent weekly (see here), without any doubt operate not only in an oligopoly, but even practically in a duopoly – which is the highest form of an oligopoly.

Together, both companies have a market share of over 90% in commercial aircraft. Boeing even had a monopoly until the 1970s before Airbus was created (see here).

Currently, it is more 40%-something for Boeing and 50%-something for Airbus, after Boeing has been suffering from quality issues since 2019.

Even though there a few smaller producers like Embraer (ISIN: BREMBRACNOR4, Ticker: EMBR3), ATR (a joint-venture between Airbus and Italian defense company Leonardo (ISIN: IT0003856405, Ticker: LDO) or Russian United Aircraft Corporation and Chinese Comac, the fact of the matter is that airplane making is not a world-wide competitive environment.

Besides the fact that this is a highly cyclical industry, the business is not ultra high-margin. Their services are (like everywhere else), but the hardware production is not.

Not something that is expected for a duopoly.

Below, you can see operating margins of Boeing (blue) and Airbus (black).

Despite services having operating margins of somewhere between 15–20%, overall the picture doesn’t look like a strong oligopolistic market, offering an attractive investment opportunity. If we add individual problems like is the case currently with Boeing, then one definitely cannot say that pick just both and good is.

It is unlikely to have great buy and hold forever investments here.

Plus, big swings up and down due to cyclicality are better to be expected.

Beverage / Aluminum can producers

This is a bit simplified, because the following companies are not only producing aluminum beverage cans, but also other packing and even some aerospace or defense supplies.

Nonetheless, these names are rather not so well known to the general public. Try to have a closer look at your beer can if you hold one in your hand next time.

A name like in my case Ball Corp. (ISIN: US0584981064, Ticker: BALL) or its competitor Crown Holdings (ISIN: US2283681060, Ticker: CCK) is very likely to appear. There are other names from the UK and Japan, but these are the two big fish.

Ball is the market leader in this segment.

However, it has been struggling pretty much due to high investments, a tough market environment with less growth than expected, high energy costs and especially higher interest rates which increased the cost of debt – which Ball had plenty of with almost 9 bn. USD at the end of 2022 compared to operating cash flows of never being above 2 bn. USD, often even way less (and barely any free cash flow).

It is a capital- (and energy-) intensive business with ultra weak free cash flow margins, never having come close to 10%, even in an environment of quasi low interest rates.

Below you can see how the stocks of Ball (pink) and Crown Holdings (orange) developed over the last three years when interest rates climbed back up.

Both clearly have been hit hard, massively lagging the S&P 500.

It seems, though, as if both could have turned the corner.

Ball has sold its aerospace and defense segment to reduce debt and buy back shares. Over the very long-term, this was even a successful investment, as the chart shows:

But this does not change the fact that recently growth has been non-existent and cash generation is weak while investments are high.

Cash flow per share is lower than ten years ago for Ball and only slightly higher for Crown.

High debt, high investments and low margins don’t look like a no-brainer industry, but more like a troubled sector where timing is everything.

I would not pay a 22x multiple (without including still not low debt) for such a company like Ball.

Tobacco

I already discussed tobacco stocks on two occasions (here and here), so I am reiterating here that my view on this declining industry hasn’t changed.

While the sector has been hated for 70 years or so when it peaked somewhere in the 1950s regarding smoking volumes, it has held up not only well, but offered outsized returns for shareholders until about 2017 when things broke.

I guess for good.

Volumes are dropping too fast for price increases to counterbalance shrinking revenues, especially in the case of Altria (ISIN: US02209S1033, Ticker: MO) which is not able to keep sales stable anymore – despite frequent price hikes.

The highly appraised alternatives for the foreseeable future, are unlikely to step in successfully, maybe with the exception of Philip Morris (ISIN: US7181721090, Ticker: PM) which is approaching 40% of its sales from non-combustibles. However, they don’t break down profitability so my first thoughts are there’s something to hide.

For all others, they’ll need lots of marketing efforts and winning consumers first, before a possible pay-off.

For me, what has worked until a few years ago, does not anymore now.

The headwinds are too big and the valuations not low enough. And regarding a maintenance free sector wide investment, I’d be cautious not to buy into a bunch of losers.

Telecoms

This is a tough topic, because one needs to look at geographies individually.

But let’s take the US market, where AT&T (ISIN: US00206R1023, Ticker: T) and Verizon (ISIN: US92343V1044, Ticker: VZ) are way off their former all-time highs.

Both are heavily struggling due to massive debt loads, while at the same time continuous investments are needed to stay competitive. T-Mobile US (ISIN: US8725901040, Ticker: TMUS) on the other hand and while also heavily indebted, has grown into more than just a serious challenger.

TMUS is growing strongly and aggressively which the market is rewarding with all-time highs for the stock.

But as a whole, this oligopoly certainly is not investable.

Too much debt, high capital intensity, barely any growth across the board, a past of questionable and destructive acquisitions. No thank you.

It is similar in Europe, where Vodafone (ISIN: GB00BH4HKS39, Ticker: VOD) has been struggling for years as it is not growing anymore while facing a heavy debt burden. Now, it pitching itself with focussing on its core markets. Businesses in Spain or Italy are being sold as competition is hard. But it is also true that Vodafone needs money to pay off its massive debt load which is almost twice the equity value.

On the other side, Deutsche Telekom (ISIN: DE0005557508, Ticker: DTE) seems to have waken up, at least its stock. Part of the truth is, though, that as a majority shareholder of T-Mobile US, it is benefitting from TMUS’ growth. But nonetheless, the stock of Deutsche Telekom is going up currently.

The result is the same with telecoms as a whole sector – not promising and very tough.

Here’s how the stocks of DTE (orange) and VOD (blue) did over the last ten years (without dividends).

Airlines and cruise lines

I decided to group them together.

Both are heavily cyclical businesses with the need for high capital investments to maintain and expand their fleets. Then you have on top energy costs which can hit them really hard through sudden spikes or a prolonged elevated level.

Airlines have frequently gone bankrupt and either reemerged or disappeared entirely. But through lots of consolidation, market shares are high for a few selected players.

This applies to the US market, but also to Europe.

Regarding cruise lines, we have a behemoth with more than 50% market share, Carnival (ISIN: PA1436583006, Ticker: CCL) and then Norwegian Cruise Line (ISIN: BMG667211046, Ticker: NCLH) as well as Royal Caribbean Cruises (ISIN: LR0008862868, Ticker: RCL) as the big pure-play names.

There are also a few specialized niche-names and also some tourism companies offering cruise trips, but the above are the oligopoly.

Needless to say that cruise lines have been hit hard with the lockdowns and travel restrictions from which they haven’t recovered until today.

As they’re troubled with huge debt burdens while free cash flow is quasi non-existent, the question does not even arise for me to look for an investment here as the risks are way too high being in a muted economic situation – despite tourism still doing well.

With this, now let’s have a look at more promising and even successful oligopolistic markets with promising setups or where the whole sector has done well over time.

Music

On the music side of media, we have an oligopoly consisting of Universal Music (ISIN: NL0015000IY2, Ticker: UMG), Warner Music (ISIN: US9345502036, Ticker: WMG) and the music arm of Sony (ISIN: JP3435000009, Ticker: 6758) which as we know is not a pure play.

The three share about two-thirds of the music label market while the rest are independents. UMG is the leader of the pack.

UMG and WMG haven’t been public for that long. But they have respectable results with good margins.

While the streaming revolution was the beginning of a revival of this once-dead industry, I am not jumping in hands-over first. WMG has too much debt and both are not cheap, respectively offering too little expected returns.

Currently, you’re paying 24x enterprise value to free cash flow for Warner Music and even 33x for Universal Music. Both are not growing enough to justify such a premium.

But nothing speaks against observing this sector.

Energy – oil and coal

Everyone knows Big Oil, so we do not have to talk too much about it.

Oil is a cyclical market, but the companies have become more disciplined on a financial front instead of spending recklessly just for the barrels. Long-term, they’ve done well and the will likely do so for the time being.

However, I prefer smaller and more clear-cut cases where there’s definitely more upside, while the setups are even better with lower costs, longer reserve life, organic growth, etc.

In two of my reports for example, I wrote about companies with assets in Namibia or Argentina (both for Premium Plus members).

Regarding coal, especially met coal, we also have a rather consolidated market.

The highest quality met coal comes from Canada, the US and Australia, so we are also having a quasi-oligopoly on a geographic level. In the US for example, Alpha Metallurgical Resources (ISIN: US0207641061, Ticker: AMR) and my pick for my Premium members, Arch Resources (ISIN: US03940R1077, Ticker: ARCH) together hold more than 50%.

What’s interesting regarding coal and in comparison to oil is that coal producers have become truly asset-light businesses. They barely invest because new mines don’t get approval and besides there’s not much to invest.

So, despite the cyclicality, capital intensity is low, margins are high and free cash flows together with low valuations (less than tobacco stocks with better balance sheets) allow for generous shareholder return programs.

This industry went into bankruptcy due to debt in 2017. Today, most companies are debt free.

For me, this is the new tobacco sector. Hated, but the numbers are great.

Big Tech

There’s not much to explain. Big Tech stocks have had a great time since the Financial Crisis of 2008-2009.

The question is only, will it last?

Debt is not a problem, as they have super clean balance sheets. But growth has its limitations. They are also cornerstone investments in every novice portfolio. So, I do not feel the urgency to be on board here, but I must recognize that the returns have been great.

One of the keys besides strong balance sheets and no net debt, clearly has been the strong free cash flow generation. Actually, these businesses are cyclical, because many of them have an advertising component – and ads are cyclical in nature.

But until here, they’ve been able to defy gravity. Let’s see for how long.

Credit Cards

Visa (ISIN: US92826C8394, Ticker: V) and Mastercard (ISIN: US57636Q1040, Ticker: MA) are often named first. Let’s also throw in American Express (ISIN: US0258161092, Ticker: AXP).

The latter has a slightly different business model, as it is not just collecting fees but also interest income from loans.

But all have asset-light business models, very high margins and quasi no competition. As a plus, they enjoy tailwinds through an ever growing share of digital and card payments.

So here, given one is okay with the valuations, all names should do well.

Elevators and escalators

This market is indeed also oligopolistic.

Names you should have heard of or even seen in your everyday life are Finish Kone (ISIN: FI0009013403, Ticker: KNEBV), Swiss Schindler (ISIN: CH0024638196, Ticker: SCHN), American Otis (ISIN: US68902V1070, Ticker: OTIS) and German TK Elevators (private).

Next time you’re in an elevator or driving up or down on an escalator, keep an eye open.

While TK elevators was inside a much larger entity (thought the crown jewel there), the other three are still tradable and focussed. All have done okay to well, however, their environment is also cyclical.

The business contains a hardware and a high-margin service business.

What I find interesting about this sector is that despite lots of moving parts, these companies are asset-light business with strong free cash flow generation. This is not only due to their service arms, but they don’t hold the materials and components on their balance sheets in inventory – like aircraft makers do.

They order them onsite, do their construction work and later pay their suppliers.

Since the IPO of Otis (when it was spun-off from former United Technologies), Kone and Schindler haven’t moved pretty much while Otis almost doubled. Over the long-term though, since 2005, Kone is up 8x (temporarily even more than 10x) and Schindler at least roughly 4x. They are also paying dividends on top.

As long as one is convinced that the world economy moves forward (or up and down) and that especially emerging markets continue to make leaps forward, this could be an idea to think about.

But it comes at a price I am not willing to pay currently. Schindler trades at 22x EV / FCF, the other two above 30x.

That’s too much.

Soft and energy drinks plus fast food

These can all be grouped together and gone through rather quickly, as Coca-Cola (ISIN: US1912161007, Ticker: KO), Pepsi (ISIN: US7134481081, Ticker: PEP) and Keurig Dr. Pepper (ISIN: US49271V1008, Ticker: KDP) are well-known household names in the soft drinks space.

Regarding energy drinks, we have Red Bull (private), Monster Beverage (ISIN: US61174X1090, Ticker: MNST – see my older weekly about it here) as well as a new contender with Celsius (ISIN: US15118V2079, Ticker: CELH).

In fast food, after mentioning McDonald’s (ISIN: US5801351017, Ticker: MCD) and Burger King respectively its parent company Restaurant Brands (ISIN: CA76131D1033, Ticker: QSR) I cannot really name big competitors. There are local offerings and one can debate whether Domino’s Pizza (ISIN: US25754A2015, Ticker: DPZ) should be included.

But all in all, we have oligopolistic markets with big names.

The businesses are high-margin, still growing, albeit slowly and the companies are throwing off cash flows for their shareholders. And the stocks did well in the past.

Basically, one could pick a basket of all and do fine.

For me, they are not interesting, because I am not comfortable with their valuations.

So, what is my bottom line?

Oligopolies are not automatically no-brainer investments. It certainly depends on a few key points like:

• cyclicality of the business and where we are in the cycle
• structural tailwinds vs. headwinds
• debt and balance sheet strenght
• asset-light vs. capital intensive businesses
• margins and cash flow generation

Little surprisingly, no investment without due diligence!

While it might sound smart to buy a bit of everything if one either does not want to or does not know how to check the fundamentals to buy pretend safety, I see this as even a riskier approach. With too much spread bets, one limits the upside while at the same time there is no protection in the case of sector-wide issues.

I would and will take one or two steps back from trouble-ridden companies where risks are high and the potential questionable.

Hard numbers will remain an integral part of every decision and avoiding trouble is never a bad idea.

If a business has structural problems, you’ll see it in the numbers.

Conclusion

Oligopolies sound like smart investments as market shares are high and competition is limited.

So at least the theory. Practically, this does not protect the companies from sector-wide events or the business cycle.

Before every investment, due diligence is required.

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