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Friday Five: Few Answers From the Fed

Fri, 21 Aug 2015

Plus, a recap of this week's big retail earnings reports.

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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: Last week you said the Fed minutes coming out this week probably would not tell you so much. After we got those minutes this week, what are your insights?

Glaser: There wasn't a whole lot of new information in these minutes. The Fed thinks that we are approaching the type of conditions that would make a rate hike seem reasonable. But if those conditions are going to be met in September or in December or maybe in 2016, we just don't know yet.

There seems to be two factions: Some people want to wait until inflation looks a little bit stronger before moving; others think it's important to get the ball rolling on rate hikes to show the market that they are serious about returning to a more normal monetary policy. We just don't know which of these factions is going to win out.

As we've discussed before, the August jobs report is going to be important. It is one of the big pieces of data that the Fed doesn't have yet before they go into their September meeting, and that could be a big factor affecting whether a rate hike happens now or later. But either way, investors shouldn't be too concerned about the exact timing of this rate hike. The Fed is still very much on track to do it. It doesn't seem like they are thinking we should have zero rates for an indeterminate amount of time like they had said before, and I think the exact timing shouldn't be something that stresses you out.

Stipp: Wal-Mart shares sold off after they reported earnings this week. The company is making some big investments. Are any of those investments paying off?

Glaser: They are making investments, both in their labor force through higher wages and also in their e-commerce platform, and that's really weighing on profitability. It's something that the investment community and the stock market is a little bit concerned about, and we've seen the shares sell off because of it.

But you are seeing some top-line growth, and I think some of their investments are starting to pay off. In the U.S., same-store sales growth was up 1.5%; that's a good number for Wal-Mart. Outside the U.S., growth was up 2.8%, and that excludes the impact of the stronger dollar. So there are signs that operationally, on the top line, things are looking better.

Their profitability fell, like we discussed, to 4.5%, but Ken Perkins, our Wal-Mart analyst, thinks that these investments makes sense over the long term--that they are going to help Wal-Mart be more profitable over time, stay relevant, and ensure that they can compete against the likes of Amazon, which is obviously investing very heavily as well in its retailing and ecommerce platforms. It's interesting to see Wal-Mart continuing to invest to make sure that they can keep up.

Shares do look undervalued at this point, given how they've been selling off, and it could be an attractive opportunity for investors to take a look at.

Stipp: On the other hand, Target results show that they are on some positive trends. How is that story different than Walmart's and is there any opportunity in that stock?

Glaser: In some ways they are a bit of a contrast. Target did have better growth as well. Top-line same-store sales growth was 2.4%. But remember they are still lapping some weak numbers from the data breach issues that they were having. So those comps aren't really apples-to-apples when looking at Walmart's numbers.

But their gross margin came up, and they were able to bring their selling and administrative costs down, mainly by laying off some workers. They are really showing some efficiencies there and showing greater profitability.

Ken Perkins, who covers Target for us as well, thinks these trends could continue over the short term but is very skeptical that they are going to be sustainable over the long term. He sees Target's positioning as much less defensible. They are much more susceptible to online competition, and it's going to be challenging for them to differentiate themselves from some of the other players. He thinks that shares look pretty overvalued right now and that the risk/reward proposition just isn't there given some of these long-term issues.

Stipp: Earnings results from Home Depot showed their customers were opening their wallets and making bigger purchases. What was behind some of the success they saw?

Glaser: Home Depot had a good quarter. Their same-store sales were up 4.2% on the back of an improving housing market. Like you mentioned, not only are they seeing sales go up, but they are seeing sales of higher-ticket items increase. Transactions over $900 were up over 6% in the quarter, as homeowners feel more confident to go out and buy appliances.

There were also good signs from their professional business--sales to professionals. This has been an area that Home Depot has identified for growth. They purchased Interline, which sells repair and remodel products to professionals. That helps expand their presence with these customers as well. And there were signs that was working for them.

Shares do look overvalued right now, according to Morningstar analyst Jaime Katz, but given that there probably is still some room left in the housing recovery--and some other data this week seem to confirm that--if Home Depot shares were to sell off and they did become a little bit less expensive, it could be another interesting name to consider.

Stipp: Another retailer seeing good results in their quarter was TJX. What was their secret to success, and why did they see better-than-expected results?

Glaser: Last we talked about Macy's and how they were having some trouble driving sales growth, and it seems like one of the players that's taking market share and growing at their expense is TJX, which runs T.J. Maxx, Marshalls and HomeGoods. They saw their sales grow up well above expectations, and it really seems like management's ability to have a leaner, more responsive inventory management system has helped them in a big way, as they were able to have the products that customers want right when they want them. They probably were able to take advantage of some of the West Coast port delays in order to get some discounts on merchandise they had been sitting around for a while and that other retailers didn't know what to do with. Operational excellence from TJX really came out in the quarter.

Unfortunately, it isn't a big secret that they have been performing well, and it's priced into the stock right now, but this is another retailer that has a narrow moat and is worth keeping on your radar screen if it's something you'd be interesting in owning. There is a chance they have a quarter where they stumble or they have a period of weakness, and if we were to see the shares sell off, it could be an interesting one for your portfolio.

Stipp: Great recap of retail earnings plus the Fed's frame of mind. Thanks for joining me, Jeremy.

Glaser: You're welcome, Jason.

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

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