7 Companies with Unrivaled Economies of Scale

This is the first in a new series of articles highlighting dividend companies that specifically have large and durable economic advantages, or “moats”, that protect their business operations and allow years or decades of strong profitability. When looking for long-term investments, one typically wants to find a business that isn’t just doing well simply because management is on top of their game right now, but rather because the business itself has fundamental and difficult to replicate advantages over its competitors.

Companies that have large economies of scale have durable advantages over their competitors because they have logistic or price advantages, and therefore attract more customers and solidify their size advantage even more. It creates a feedback loop of success that rivals have a difficult time dealing with. Companies that compete against larger rivals have price and efficiency disadvantages, and usually must sacrifice profitability levels to even stay in the game, or must try to change the nature of the game to circumvent the moat.

This article provides 7 examples of companies that have a dramatic size that they utilize efficiently to keep competitors from catching up, matching their prices, or competing with their established distribution networks.

Procter and Gamble (PG, Financial)

Procter and Gamble (PG) is a large brand management company. The company owns more than 20 billion-dollar-brands, and another 20 or more half-billion-dollar brands, mostly in the area of consumer products. Procter and Gamble’s extensive distribution network allows it to reach over 4 billion customers, with plans to reach up to 5 billion customers in the next few years as they continue their international expansion. The company spends more money on consumer and market research than any other corporation.

Market Capitalization: $180 billion

Revenue: $84 billion

Return on Equity: 18%

Dividend Yield: 3.20%

Wal-Mart Stores (WMT, Financial)

Walmart (WMT) is the largest US supplier of groceries, and the largest US general retailer. They can buy in such enormous bulk, and force suppliers to accept such low prices, so they can sell at low prices to customers. Costco has been piercing Walmart’s moat by accepting a net profit margin of half of what Walmart has, in an attempt to compete on price and to grow. Amazon’s amazingly quick growth with its online retail model poses a threat as well. But the United States has the largest income inequality among any large and developed nation, and it’s also one of the only developed countries that is expected to have sustained population growth over the next several decades. Walmart, with its low prices, targets the millions of low income Americans and so even with well-performing competitors, I find it unlikely that Walmart will be dislodged from its position any time soon. I believe the next ten years will likely result in much better returns for WMT stock than the last ten years, since I expect their EPS growth to continue, and the stock is not overvalued as it was ten years ago.

Market Capitalization: $203 billion

Total Revenue: $440 billion

Return on Equity: 25%

Dividend Yield: 2.46%

ExxonMobil Corporation (XOM, Financial)

Exxon Mobil (XOM) is the largest of the oil supermajors, and one of the largest publicly traded companies in the world. The only oil producers larger than XOM are certain state-owned oil producers. Due to scale, as well as XOM’s strict focus on hydrocarbons instead of alternative energy sources, XOM has better margins per barrel than its competitors. In addition to oil production, XOM has a huge presence in US domestic natural gas production, which will be an important energy source for quite some time. In addition, XOM is one of the largest refiners. Their upstream segment is by far their largest, but their downstream and chemical segments are still enormous. Over the last 12 months alone, with nearly a half-trillion dollars in revenue, XOM has brought in almost $58 billion in operating cash flows and spent more than $30 billion on capital expenditures. The company manages high return on equity while simultaneously keeping leverage to a minimum, with a total debt/equity ratio of only 0.11.

Market Capitalization: $408 billion

Total Revenue: $470 billion

Return on Equity: 27%

Dividend Yield: 2.21%

United Parcel Service (UPS, Financial)

In 2002, Deutsche Post, the world’s largest logistics company, acquired DHL Express, a US-based carrier. In 2003, Deutsche Post acquired Airborne Express, an express carrier and air cargo company. The plan was to compete with UPS and FedEx in domestic US shipping. After five years and over $10 billion in losses, Deutsche Post gave up and left the US domestic shipping market. They simply couldn’t compete with the duopoly of UPS and FexEx. UPS and its rival FedEx are simply too large, and have such breadth of entrenched distribution networks, that one of the largest companies in the world couldn’t dislodge them even after a sustained effort. With the takeoff in online retailers (which need to ship individual packages all over the country), as well as the continued net losses of the United States Postal Service, I can only expect that UPS and its smaller rival FedEx will continue to grow and further strengthen their already formidable positions. UPS alone delivers over 15 million packages a day, and regularly delivers to over 200 countries and territories.

Market Capitalization: $72 billion

Total Revenue: $52 billion

Return on Equity: 50%

Dividend Yield: 2.79%

Compass Minerals (CMP, Financial)

An inclusion of the example of Compass Minerals (CMP) shows that a company doesn’t have to be big to harness economies of scale; they simply have to be the biggest in their respective industries. More specifically, Compass Minerals operates some of the biggest salt mines in the world, including the largest underground salt mine in the world: the Goderich, Ontario salt mine. Not only is this mine the largest, it’s also conveniently located on the Great Lakes, which allows ships and trains to transport the salt very efficiently across a significant portion of the United States. So, Compass produces a commodity product at a price that’s usually lower than competitors; and it’s due to a geographically non-replicable situation. With decades of salt production still available, as well as diversification into a number of salt mines as well as fertilizer production, Compass has a pretty strong set of defenses against competitors. The company is paying down rather substantial debt levels, and faces weather-related risk.

Market Capitalization: $2.3 billion

Total Revenue: $1.16 billion

Return on Equity: 45%

Dividend Yield: 2.57%

Exelon Corporation (EXC, Financial)

Exelon (EXC) is the largest operator of nuclear power plants in the United States, with 17 reactors in 10 plants. The enormous construction cost of nuclear power plants, the political disinterest in allowing construction of new plants, coupled with their low operating expense, allows Exelon to produce low cost energy that is difficult to rival. In recent years, inexpensive natural gas prices breached the moat a bit, but overall, with Exelon’s energy diversity (which will be expanded with their Constellation Energy acquisition), and with increasing regulations against coal power plant emissions, Exelon looks profitable to me for the long term.

Market Capitalization: $27 billion

Total Revenue: $19 billion

Return on Equity: 17%

Dividend Yield: 5.19%

Intel Corporation (INTC, Financial)

Intel (INTC) does have substantial technological rivals, but their research and development budget (upwards of $7 billion annually) is difficult to compete with. AMD, for instance, put up a good run several years ago but couldn’t keep pace with Intel over a multi-year time frame. Intel’s semiconductor market dominance, rock solid balance sheet, and large R&D expenditure, allow the company to consistently produce cutting edge processors, and when caught off guard, gives them time to adapt to market rivals. The company has a near-monopoly in the PC processor market, but is significantly behind, due to power inefficiency, in the mobile computing market.

Market Capitalization: $131 billion

Total Revenue: $51 billion

Return on Equity: 27%

Dividend Yield: 3.26%

Full Disclosure: At the time of this writing, I own shares of PG and XOM.