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Unpleasant Surprises

Fri, 18 Jan 2013

How bad was bad news this week from Apple, Boeing, Bank of America, and others?

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five.

It was surprise, surprise in the market this week, and not always in a good way.

Here with five unpleasant surprises is Morningstar markets editor, Jeremy Glaser.

Jeremy, thanks for joining me.

Jeremy Glaser: Jason, glad to be here.

Stipp: So, what do you have for The Friday Five this week?

Glaser: Well, we are going to talk about Apple, UPS, eBay, Boeing and finally Bank of America.

Stipp: So, Apple had some unpleasant news, or news that was taken unpleasantly by a lot of investors, when they said that they weren't going to ship as many of the screens for the iPhone 5. What are the implications here?

Glaser: Last week there were some news reports in The Wall Street Journal and elsewhere that Apple had slashed its orders for the screens for the iPhone 5 by as much as 50%. And the stock sold off pretty sharply on this news as it was seen as a sign that iPhone demand, particularly in emerging markets, is much weaker than anyone had expected.

But our [Apple] analyst Brian Colello looked at it a little bit differently and said that we just don't know what these order cuts could mean. It could just be that Apple was trying to spread their orders around a bunch of different suppliers, worrying about a bankruptcy, particularly at Sharp, which has been undergoing some very serious financial troubles recently, and that this was more of a normal cut in inventory, that it wasn't just this dire warning that the iPhone business is about to completely explode.

The way that he looks at it, and the way to think about the stock, is that even if iPhone doesn't have the kind of gangbuster growth that it has been having before, at these valuation levels a lot of that could start to get priced in, and you don't need to see huge margin expansion, don't need to see the kind of sales growth we saw in the past in order to support where the shares are today.

And so he still thinks that the stock looks attractive, and when you look at the iPad still having a lot of growth in front of it, potential revenue from new products like the Apple TV and other things that they might introduce, he still sees the story as being pretty compelling.

Stipp: Unpleasant news for UPS in its bid for TNT. What are the details there?

<TRANSCRIPT>

Glaser: The European Commission said that UPS is not going to be able to complete a $6.3 billion deal to buy the logistics firm TNT in Europe. UPS was going to use this to get even more of a foothold in those countries in Europe, and it was a deal that I think was broadly expected to go through. It was clear that they were going to have to make some concessions, for example, they couldn't own the airline the TNT owns because U.S. firms are not allowed to own European airlines, but it was somewhat surprising that they just were totally told it wasn't going to happen, and that there were no amount of divestitures they can do in order to complete the deal.

So, TNT is going to get about a 200 million euro breakup fee from UPS. It's not going to be a huge impact for the American package giant; they'll still be able to probably continue without it. But [the commission decision was] certainly something that was a little bit unexpected.

Our [UPS] analyst Keith Schoonmaker thinks that the shares are currently fairly valued for UPS, and he doesn't plan to make any changes because of this move.

Stipp: Online auction king eBay reported this week. Some analysts might have seen their forecast as a bit of an unpleasant surprise, but our analyst looks at this company and says, hey they are still sitting pretty.

Glaser: Our [eBay] analyst RJ Hottovy took a look at these earnings and saw even more evidence that our thesis that eBay has a really wide economic moat and has great competitive advantages is very much in place, and that comes from two areas.

The first is marketplace, the traditional [eBay customer activity]: You go on to eBay, you want to sell your iPad, you want to buy a new iPad, something like that. There is a huge network effect there; no one else has come even close to replicating the scale that eBay has.

But also for PayPal. Payments are becoming increasingly important and they are becoming an area where there is a lot of experimentation now that online or offline retailers are accepting PayPal. Consumers and merchants are trying to find ways to lower those interchange fees, to lower their transaction cost when they are taking cashless payments. PayPal is really well positioned there and has that scale where they are able to keep some of the smaller competitors out of their core markets.

So as eBay moves more into mobile, as more people are using both PayPal and the marketplace with mobile [devices], they have even more opportunities to increase their cash flow over the years. RJ sees midteens revenue growth over the next couple of years, which is pretty impressive for the firm. Unfortunately the shares do not look particularly cheap at the moment, which is true over lot of the market, but if there were to be a sell-off, if we were to see some volatility in the coming weeks, it could be an interesting name to keep on your radar screen.

Stipp: Stakes got even higher for Boeing this week, news of other issues with the Dreamliner and now a grounding of the airlines. How serious is this problem for Boeing?

Glaser: It could get pretty serious for them. The Dreamliner has had a lot of headaches and has created a lot of headaches for Boeing, from the huge delays in the development to get those shipments to customers and now that the planes are in the customers' hands, there's some safety concerns.

After a fire on a Japanese jet at Boston's Logan Airport and an emergency landing in Japan, Japan, the United States, and Europe have grounded the 787 [pending] further safety review.

We won't know exactly what the impact is going to be until we know what the outcome of this review is. If it's a simple fix, if it just seems like the lithium batteries need to be replaced or need to be connected in different way, Boeing will probably be able to ride it out. But if it's something that's a lot more serious that they are going to have to go back and do a lot of remanufacturing on existing planes and continue to refine the manufacturing process, it could have a pretty serious impact.

They have almost 800 aircraft that they have not yet delivered, that are ordered on the Dreamliner program, and a lot of those orders are predicated on them being able to ramp up production and being able to get up to their peak production levels. If they keep finding problems like this and FAA tells them they need to fix more problems, it's going to slow that down. By slowing that down, that slows when that revenue comes to the door, and makes it more challenging for them.

You also have to worry about customer perception issues. If consumers keep hearing about these safety problems, they might decide that the 787 is not an aircraft they want to fly on; they might try to avoid it. And this could lead to problems with potential cancellations, could lead to problems with future orders. They have a lot riding on these new aircraft, and the outcome of these investigations and getting that safety record up to where people expect is going to be a big part of being able to get the financial gains from the design work that they've done.

Stipp: Bank of America reported this week, and I can't say that I'm surprised to find them on the unpleasant surprises list. What was it this time?

Glaser: It's more of the same. Bank of America has so many unusual items that they are really no longer unusual. Every quarter we see more litigation, more mortgage risk, more issues particularly with their Countrywide unit, and it just keeps coming up over and over again in the company's earnings.

That's not to say that Bank of America is not much stronger now than it was at the peak of the financial crisis. They've raised a lot of capital. Management is starting to make a lot of room on the cost-cutting side of things, so it's not that Bank of America is in dire straits by any stretch of the imagination. But particularly compared to a lot of their peers, they keep seeing more problems, … a lot of these legacy issues just keep popping up, and they can't seem to quite get over that hump to the point where you can figure out what their earnings power looks like.

Our [Bank of America] analyst Jim Sinegal wrote this week after earnings that the biggest issue with investing in Bank of America is you don't know what that core earnings power is. If you're looking out 10 years from now, it's not exactly clear what they are going to be able to bring in versus some of their competitors like, let's say, J.P. Morgan. That's one reason investors might want to be a little bit more skeptical and want to have a bigger margin of safety before they buy into [Bank of America].

Stipp: Jeremy, never an unpleasant surprise on the Friday Five. Thanks for joining me again this week.

Glaser: You're welcome, Jason.

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

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