Home>Video>Friday Five: What's Weighing on Earnings?

Friday Five: What's Weighing on Earnings?

Thu, 29 Jan 2015

Though Apple had a record-breaking quarter, the energy slide and strong dollar have been fierce headwinds for many other firms.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories in the market this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: Let's start with Greece this week. Their elections were as expected and now there is a big focus on potentially renegotiating the terms of their bailout. What's the potential fallout here?

Glaser: This was a busy earnings week, but I wanted to start in Greece, as this has the potential to be quite an important story in the weeks and months ahead.

As expected, Greece got a new government, and there was a little bit of a shockwave through, particularly, the Greek financial system, as the government started to take steps to make good on their campaign pledges of trying to roll back some of the austerity measures and to renegotiate the terms of the bailout that they received a few years ago, in order to reduce some of the pain that the Greek people have felt during this time.

And as that happened, Greek stocks sold off pretty substantially, particularly Greek banks. But the rest of the European markets, although they felt it, you didn't see nearly the kind of reaction that you got with the Greek markets, which leads me to believe that the market is guessing that this is just going to be another road bump, but that they will basically muddle through somehow, and that if they don't, the potential downside of Greece leaving the eurozone is much less worse today, is much more contained now, than maybe it was just a few years ago.

I think the muddle-through scenario is probably still the most likely, and they will find some way to make everyone, if not happy, at least a little bit less unhappy to the point where they will be able to continue down this path. Europe is, in fact, a little bit better prepared to handle a Greek exit now than it was a few years ago. I still don't think it will be quite as painless as some think, but definitely not the kind of potential problems we would have seen before.

For investors who are worried about this, one of the key things to watch will be what's happening with the bonds of other peripheral countries. Are we seeing that contagion come out of the Greek markets and into other markets? Are investors starting to get worried about that? That could be a sign that there is still some contagion there. It's a little bit tricky to detect with ECB's bond-buying program simultaneously starting up, but I think that definitely will be one of the key metrics to watch.

Stipp: It was a big earnings week this week, as you said, and one of the headliners was Apple. They blew past analysts' expectations, and it was all about the iPhone.

Glaser: This was a record quarter for Apple and really for corporate America generally, at least in nominal terms, and it was driven by iPhone sales. 74.5 million phones sold are well above both Apple's and analysts' expectations. Everyone seems to want this new device. And even the selling price went up, too, as there was a mix shift toward the 6 Plus, which obviously sells for more money, and the higher-memory versions of the iPhone. People were buying more than just the cheapest models, and I think that's very heartening to Apple investors right now.

It's also heartening to see that Apple was willing to take a look at the market and make changes to its business strategy in order to address a need that they weren't meeting [because they lacked] larger-screen phones. They had said that they were happy with the smaller screens that they had, and that consumers didn't really want the bigger screens. But as Android was taking share and Samsung was doing well, they saw that opportunity, and they were able to create a good product around it, and obviously it was very well received. I think that investors should take that as a good sign that Apple really is listening to consumers.

Brian Colello, our Apple analyst, raised his fair value estimate to $120 a share on the news, but there is not a big value in Apple's shares right now. They are trading around their fair value estimate, but it doesn't seem like the expectations baked into the stock are unreasonable right now.

Stipp: On the flipside, Alibaba reported disappointing results, and their shares took a hit because of that.

Glaser: They did. Alibaba shares sank after its revenue growth didn't meet expectations. There are two big things behind this--first, a move toward more mobile users. Alibaba doesn't make as much money off mobile users as desktop users. So as mobile users become a bigger part of the mix, the revenue growth is going to slow.

Alibaba is also doing some user experience investments that slowed revenue growth somewhat, and that really showed up in the numbers.

But R.J. Hottovy, our Alibaba analyst, thinks that neither of these are reasons to be concerned about the competitive positioning of Alibaba. Companies need to make user-experience investments to keep customers on your platform, to make sure that you don't lose the value of that network effect.

And people are going to be moving to mobile--this is just a fact of life--and Alibaba is starting to make the kind of changes that they need to have monetization levels on mobile users continuing to rise. As more people move there, it should be easier for them to do. Also the fact that they are not trying to actively fight [that secular shift] is a sign that they know where the future is.

But even after the shares sold off, there is still not a great value there. We do have a High fair uncertainty rating on Alibaba, given that there are some concerns. You just never know on some regulatory issues. For example, this week one of the Chinese regulators accused Alibaba of selling counterfeit goods on the site. Alibaba has denied those allegations, but issues like that demand that you have a fairly large margin of safety before getting into the shares, and that's just not available right now.

Stipp: We've been seeing some casualties of the energy sell-off in earnings, and a new one emerged this week, Caterpillar. They certainly felt some effects from the energy slide.

Glaser: They did. Caterpillar has been hurt by that because a lot of their customers who have exposure to commodities, to energy prices, aren't buying new equipment right now. Management gave some pretty poor guidance for 2015--a 25% decline in earnings per share from the year-ago period--and that was much worse than analysts had been expecting.

That number could stay pretty weak for some time. Our Caterpillar analyst, Kwame Webb, says that this is the kind of situation where it's not just that commodity prices would have to come up a little bit and then Caterpillar's customers will be back. Prices would have to stay at sustained higher levels until there is enough confidence for people to start ordering some of these big equipment pieces.

That being said, though, he doesn't think this is a real structural issue for Caterpillar. It's more of a cyclical issue. These things tend to move in cycles; once energy prices do eventually come back--or even if they don't come back to their previous highs, but they come back off these lows--there will be new orders and the wide moat that Caterpillar has built is still very much intact. Shares don't look particularly attractive right now, but I don't think there are any worries, at least at the moment, about the competitive positioning of Caterpillar.

Stipp: Another big theme we've been seeing in earnings is the effect of the strong dollar. We saw that show up across multinational companies, but especially P&G this week.

Glaser: The strong dollar really hurt Procter & Gamble. They reported a sales decline of 4% and said for the fiscal year they are going to see a 5-percentage-point headwind from currency issues, and that's much more than many people had initially thought.

In fact, when you look at their organic sales, which strips out currency, divestitures, and some other special items, there was a 2% increase in sales. So clearly currency is holding back Procter & Gamble right now.

This is very much a case where you need to take a deeper look into the company to see what's actually happening. Our P&G analyst Erin Lash thinks that they really are gaining traction in a lot of their businesses. They are gaining share in diapers. They are doing well in other parts of the business. They are making good progress on paring down the number of brands they have to a much more manageable number--getting rid of the underperformers--and that's a strategy that's going to serve them well.

So, these currency headwinds are going to be there, but fortunately for investors, it is opening up potentially an opportunity in the shares. They are trading for below their fair value estimate, maybe not at a huge discount, but given that we're in a market that doesn't have a lot of values, Procter & Gamble could be an interesting one to keep on your watch list.

Stipp: Great insight on the big earnings stories this week, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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